Tuesday, November 6, 2007

Keystone Co-Op #5 : The Moment of Truth

posted by deep throat

Is Time Almost Up for the Co-Op?

It looks like the Co-Op board has finally run out of time -- denial of the crushing financial problems and strategic mistakes has ceased to be an acceptable public relations strategy. Now, the current board (and the membership) face some very tough decisions.

Unfortunately, none of the alternatives is particularly attractive for the Co-Op. On November 18, a community meeting will be held and the board will present its recommendation on a course of action, and the membership will vote Yay or Nay on the board's suggestion.

From our perspective, it's about time. The status quo and on-going cash burn situation have turned the Co-Op into a sinking ship.

While some folks might have hoped for the luxury of time to let the 55th Street store continue to generate profits that would be siphoned off to pay for the on-going lease obligations at the 47th Street location and various vendors, the Co-Op has been digging itself into a deeper financial hole as each month passes because what it owes still far outstrips the cash it is able to generate.

Now the board is finally entertaining the drastic solutions that this type of situation calls for.

The board must choose from four options, two of which will allow the Co-Op's 55th Street store to remain in operation, and two that will shut that store down.

Before we assess the four approaches, we have one large caveat that must be voiced. If the board endorses an alternative that allows the 55th Street store to continue operations, the members are being asked to take a leap of faith that this board will govern responsibly, and avoid making the types of bone-headed decisions made by multiple previous boards.

That long history of bad decisions by previous Co-Op boards is what landed the Co-Op in its current situation in the first place. In our view, it is incumbent on this board to demonstrate that it can do differently, before asking for a vote.

Option A - "The Good Samaritan" - Debt Consolidation
This is similar to the low production-value, late-night television ads that offer to help those who are drowning in late payments to the utility companies, credit card companies, and other consumer lenders. It involves consolidating all the Co-Op's various debts to landlords and vendors, and then working out a plan to chip away at that mountain of debt over a long period of time.

This approach would require an entity, like a bank, to step up and take over all the Co-Op's debts and then receive payment little by little. It would also allow the Co-Op to avoid going to bankruptcy court and to continue operating the 55th Street store.

We're skeptical that any bank would actually be stupid enough to take on the consolidated debt of the Co-Op, unless management and the current board truly show that they, unlike previous boards, are ready to make difficult decisions and smart choices going forward.

Option B - "Sorry Charlie" - Creditors Left Holding the Bag
The Co-Op would negotiate with creditors to buy out the Co-Op's current leases, and shut down operations at the 55th Street store. This would not involve the bankruptcy courts.

Option C - "The Lindsay Lohan" - Going into Rehab
Like LiLo going to rehab, the Co-Op would file for Chapter 11, gain the bankruptcy court's protection, get time to reorganize its financial affairs, get its hydra-heads as straight as possible, and eventually emerge from bankruptcy in a (hopefully) healthier state.

This alternative isn't wholly unlike the 12-step program and having to apologize to those you have hurt in the past. It involves working out a new plan for paying off creditors, negotiating with every vested party (e.g., vendors, landlords, creditors, unions), and getting their agreement to the new plan.

As a result, this approach tends to involve a lot of lawyers and take a fair amount of time. But, it would allow the 55th Street store to continue operations. When the Co-Op leaves bankruptcy, the pre-petition shareholders (i.e., current members) will likely have no claim on the Co-Op, and it will instead be owned by the post-petition creditors.

In other words, whatever current members paid to buy their shares will almost certainly never come back to them.

Option D - Just Plain Vulture Food
The Co-Op would file for bankruptcy, shut down the 55th Street store, and liquidate all remaining assets. This is usually the best choice when a business is worth more dead than alive.

The Upshot
We believe Options B and D are unlikely to really happen. As with mortgage lenders when they are faced with foreclosing on a home, creditors are generally very reluctant to take ownership of the actual assets, and then put the time and resources into selling them at fire-sale prices, or worse, actually operating them. Banks want to be in the lending business, not the residential real estate business.

Banks only foreclose when it becomes clear that they'll never get their money back. We suspect that Certified and the University don't want to be on the hook for a bunch of leases with empty store space. It would be in their best interest to work out a new payment plan, which may involve smaller payments stretched over a longer period of time.

One rule of thumb: when shareholders equity is negative (as it is in the Co-Op's case), bankruptcy and reorganization is often favored. Another consideration is whether the Co-Op's assets would be put to better use elsewhere.

If so, then liquidation is the best bet for paying off creditors. In this case, it's not clear that many other parties would have use for the Co-Op's assets, which include refrigerator cases, inventory, shelving, and equity in other co-ops.

After weighing these factors, we're laying odds on the board recommending rehab. Britney, Lindsay, move over: here comes the Co-Op.


Elizabeth Fama said...

If the members are the ones who vote on this decision, why wouldn't they automatically choose A (debt consolidation)over C (bankruptcy), given that there might be a small chance they'd recover their assets under A, but no chance of it under C? (I might be misunderstanding A.)

Also, what steps do you think the board could take to prove that it can govern responsibly -- especially given that this vote might take place as soon as November 18?

Without exposing Deep Throat, can you reveal how you learned that the board is considering something drastic? Is it common knowledge among board members?

deep throat said...

The information was conveyed to us second-hand from Co-Op board president Poueymirou, via a long-time Co-Op and community member.

Yes, the board does know about this. President Poueymirou actually alluded to it in the Annual Meeting on 10/14. At the time, he explicitly said that the board was exploring many alternatives plans, which included bankruptcy. I would suspect the board has had some very intensive discussions about where to go from here.

Elizabeth -- you're absolutely right that the members would have an interest in choosing debt consolidation over bankruptcy and reorganization. However, Option A will really depend on finding a white knight. I'm not particularly confident that any white knight would be willing to take a chance on the Co-Op, given its track record of glaringly stupidity.

Also, to any members who might be harboring some distant hope of seeing a return of the money spent to buy shares, I'd suggest that you let the dream go and move on. Chances of getting anything back are nil to none.

As for the current board demonstrating that it has the mettle to take on reasonable, non-bone-headed governance responsibilities, I'd suggest that purging the board of any directors who have in the past supported the "old way" of doing things would be a place to start. Especially now that it's become clear the Co-Op is looking at a new day and must embrace a new way of doing things. This kind of house-cleaning and regime change is often a strong signal that things will be different going forward. I'd recommend purging any director who has supported any initiatives or practices that keep the Co-Op from operating in a transparent, above-board fashion, with an emphasis on doing the block and tackling necessary to efficiently run a high-quality supermarket. It's really not hard, but shoppers want a store that is well-stocked, clean, with competitive prices, and friendly service. Unfortunately, some directors have been so enamored of trying to be a co-operative, that they've lost sight of how to run a grocery store. It's disingenous and disrespectful to members for some directors to advocate strategic discussions stay in closed session. That kind of secrecy is not going to give me any confidence that this board will do anything differently than it has in the past. It's just dumb to try to reinstitute a home economist for the store when the store is dirty and shelves are empty.

One point of clarification, the meeting will take place on 11/18 for everyone to ask questions, and voting will start on 11/19 and end on 12/7. So, members will have some time to mull over what they'd like to see happen with the Co-Op.

Now that Hank Webber has suggested that the University work to bring in a new grocer to the 55th Street store location, I suspect that the U of C is among those who have lost patience with the Co-Op and aren't too willing to give it another chance. Or, maybe it's just some saber-rattling to spur the board to take drastic action.

Note: We still believe going to Rehab is option the board will favor because it keeps the Co-Op in operation. However, this is not necessarily the option that we think is best for the community. Indeed Hank Webber's suggestion also raises the possibility that rehab will be more difficult because the board will have to negotiate with the University and get it to agree to the restructuring plan. If the University is actually favoring the installation of a new grocer, then the Co-Op would face an uphill battle to get its landlord on board.

Also Note: In these types of situations where there is much uncertainty over whether the business will be a going-concern, key personnel may become flight risks, which would further weaken the Co-Op's position. In particular, I'd keep a close eye on new GM Brandfon. If he feels like the writing is on the wall, it won't be long before he jumps ship, which would also place the 55th Street store operations in jeopardy. I don't know if the board has authorized any sort of retention compensation to keep Brandfon put during this tempestuous time.

Raymond said...

The only White Knight would be the University. If, as deep throat suggests, the University has run out of patience, it's over. Sounds like the University may think Hyde Park can now support an upscale grocery store, so why throw millions at the Co-op.

I do feel sorry for the many Hyde Parkers who have thousands of dollars in Co-Op shares. Most probably have no idea what is about to happen.

chicago pop said...

Making it clear that the University has run out of patience could be the final and defining gesture of Hank Webber's career with the U of C, if he follows through on his rather determined statements in today's Herald. The rehab option would mean dragging everything out for some time. That may keep the dreamers happy, but it would preserve the status quo longer than a lot of us would like, and at the end of the day the University is still stuck running a grocery store that needs drastic modernization and overhall. Do they want that responsibility?

It's time to start over.

Elizabeth Fama said...

Raymond said, "Why [would the University] throw millions at the Co-Op?"

Well in fact, that's what the U of C has done! It has subsidized the rent to the tune of $1.2 million, and now Hank is suggesting it's willing to contribute vast sums to buy out the other creditors!

That's weird, isn't it? Why would the University gallantly do that, when bankruptcy would achieve the same goals without spending more money? My impression is that bankruptcy law allows the store to keep operating during the proceedings, so the community wouldn't be shut out of a groceries during that time. Or am I wrong?

Hank's letter to University faculty and staff says the U of C is willing to buy out the creditors in order to allow a new grocer to come in within "two weeks." Really? Won't a national grocer expect to build out the store to its own specifications? Remodeling my basement has taken 6 months!

I don't understand this offer by the University at all. It just seems strange to me.

Help me understand it Deep Throat, you're my only hope.

deep throat said...

I would personally be in favor of a clean slate -- i.e., shutting down the Co-Op entirely, and allowing a new supermarket to come in and start fresh. If the Co-Op's creditors are willing to take a bath on what the Co-Op still owes them, then maybe the Co-Op could gracefully exit without going to bankruptcy court. But, if Co-Op diehards refuse to let it pass on peacefully, then bankruptcy is a definite possibility.

Based on the new memo from Hank Webber to the University Community, it sounds like the University's preference for a new grocer is not just saber-rattling. The prospect of the long, drawn out rehab process is not attractive to the University.

The Co-Op currently owes the University $1.2 million in back rent. With the University offering to forgive most of that rent, PLUS provide funds for the Co-Op to pay off what it owes its vendors ($2.5 million based on the audited financials for fiscal 2006; we should see numbers for fiscal 2007 by this weekend), the University is basically offering to *pay* the Co-Op to shut down operations.

I must say that I'm torn on the University using its monetary resources this way. Only last week, we received two phone calls from first-year students--one to me and one to my husband--in the annual alumni appeal for donations to the endowment. The timing is poor, to say the least. I can only hope that the University isn't going to use the check I sent out to pay for the Co-Op's mistakes.

deep throat said...

Elizabeth, I'm surmising that the University figured it would be *worth* $1.2+ million to make the Co-Op go away and install a new grocer very quickly.

The bankruptcy route will cost more money in legal fees and the like. United Airlines spent about $335 million on its lawyers and consultants over the three years it was in Chapter 11, plus a ton of administrative man hours that could otherwise have been applied to growing the business. I'm not suggesting that the Co-Op would rack up that level of fees, but the lawyers would certainly get their share. And in the mean time, which could take years, the HP community would still have to limp by with Co-Op. The idea of living for another couple of years with the Co-Op's record of bumbling operations may have been too much for the University to bear. Especially since it would be a competitive disadvantage when it comes to attracting and retaining staff and students.

On a related topic, I find it interesting that the Herald's editorial indicates there are 35,000 Co-Op members. I'm very curious about the substantiation for that number. The Co-Op's own Evergreen publication pegs membership at "over 22,000" in its masthead. And, since the membership database is in major disarray (board minutes 12/06), and the membership computer had been entirely "lost" (board minutes 8/07) as of 7/13/2007, I'm doubtful the organization even has a remotely accurate count of its membership right now.

Elizabeth Fama said...

Which brings up an interesting question, Deep Throat: since the membership computer is kaput -- how will they determine who is eligible to vote?

I still get the Evergreen newspaper, even though I cashed out my $300 from the sinking ship a long time ago. I still have my member ID memorized...

Perhaps I'll be able to vote!

deep throat said...

Honestly, I don't know how the Co-Op is going to be able to screen its membership for voting eligibility. Unless a minor miracle has taken place since August -- maybe some computer fairies coming in to fix the membership computer and cleaning up the membership database -- I'm guessing the Co-Op won't be able to fully vet eligibility.