Can MEC be saved?
Sep 16, 2020
My attempt at a summary of the current MEC situation is below. Full disclaimer: There may be some mistakes. The documents and my knowledge are incomplete and I’m exhausted. At the same time, I am deeply energized by the thousands of members (including the Premier of British Columbia,) who are stepping forward and asking for increased accountability regarding this sale.
Note that the documents can be found here: https://www.alvarezandmarsal.com/MEC
Even shorter version: When combined with a modest bridge loan from the government, I think that it would be feasible for members to recapitalize MEC so that it can remain a co-operative and I think that the court should give us a chance to do that. With the Comeback Hearing scheduled for Sep 24th, there isn’t a lot of time for this to come together.
Key points:
- MEC has an operating loan that needs to be renegotiated by September 30th. In normal times, this would be a routine process of updating the agreement and potentially making some changes to the interest rate. Unfortunately, because MEC is near the upper borrowing limit and continues to lose money, the lender is unwilling to renegotiate. This means that the loan must be paid back in full. MEC does not have the funds and so they have triggered Companies’ Creditors Arrangement Act (CCAA) proceedings. Unfortunately, they have chosen an option which would see all of the assets of the co-op sold to a private company. The business activities would continue (with some stores being closed,) but it would no longer be a co-operative.
- The primary objection from members (owners) is that we were never asked if we would be willing to recapitalize the co-op before this option is taken. The board approached 224 different organizations in its search for financing options but never asked the owners themselves. I believe that this is a valid and clear objection. It is now important to find a sequence of events that will not put the transaction at risk. If members do not step up with funding, then it is better for the co-op to be sold and employees to retain their jobs than for the co-op to go through a bankruptcy proceeding. I believe that the court should provide the members with a two week period of time in which they would have an opportunity to recapitalize the co-op before the sale of the assets to the private entity is approved.
- This was a long process that started before COVID-19 and the Board had a lot of time in which it could have engaged with members. KPMG performed an audit of the 19/20 financial statements for the fiscal year that ended Feb 23rd, 2020. The Independent Auditor’s Report dated July 7th, 2020, is addressed to MEC members but was never released to the membership and is only being made available as a part of an affidavit in the CCAA proceedings. The audit reports a “Material Uncertainty Related to Going Concern”. Additionally, a consultant was hired on February 10th, 2020, to help with a number of tasks including “identifying select potential financing partners.”
Re how much the co-op owes in the short term:
- As of Feb 23rd, 2020, MEC owed $81 million on the operating loan. That has since dropped to $74 million as of Sep 11th, 2020, and the co-op is permitted to borrow an additional $19 million if needed.
- As of Feb 23rd, 2020, MEC owed $55 million to suppliers, governments and employees. Note that this is not an abnormal level of accounts payable. The year before it was $57 million. However, a note in the court documents states that: “Further, MEC has significant past due amounts owed to merchandise suppliers and other vendors” and so we should expect that the value has increased between February and today and that many accounts are now overdue.
- The court documents also note that “As of September 4, 2020, and primarily due to the Covid-19 pandemic, there was approximately $4.6 million in rent deferrals or arrears in respect of the Leases”.
Re the burn rate:
- MEC has made significant capital investments in recent years. A number of the investments are visible (opening new stores) and a number have been behind-the-scenes (new software systems and opening a new distribution center.) Arguably, MEC is now in a position where it can enter an extended period of time with a much lower rate of capital investment.
- In the 19/20 year, MEC reported a loss before patronage return of $22.7 million. In cash terms, MEC consumed $19.1 million of cash for everything excluding investing activities and the proceeds from the operating loan. In other words, MEC burned $19.1 million of cash on operations, capital lease obligations, payments received from lease inducement, financing fees, and share transactions.
- The turn-around plan was showing some promise. Salaries, wages and expenses dropped from $93.5 million in 18/19 to $87.4 million in 19/20. There were also reductions in the costs for supplies and services.
- It is not known what the burn rate during COVID-19 was. Costs would have been lower due to decreased orders for inventory and store closures. Online sales increased by 86%. Sales for the period were down by $90 million. In the coming 11 weeks, MEC is forecasting an operating cash flow burn of $11.7 million. However, this is the fall shoulder season when sales are typically low they do not provide a comparison to a prior year.
How much money would MEC need to continue operating as a co-op?
Let’s make a few assumptions:
1) The future of outdoor recreation in Canada is promising. In fact, there is growing evidence that COVID-19 may result in both short term and long term growth in this sector. Assume that COVID-19 is no longer having a materially negative impact on operations by March of 2022 (18 months from now). Further assume that MEC will make a number of operational changes that include closing under-performing stores and dropping under-performing product lines. Under these conditions, assume that MEC will be able to leverage its recent investments and its strong brand to return to operating profits in 22/23 (Feb to Feb).
2) Between now and then, assume $5 million in one-time restructuring costs and further losses of $30 million during the transition period.
3) Assume a need for $16 million to pay for past-due accounts, rent deferrals, and arrears in respect of the leases.
4) Assume that with this transformation plan in place, a traditional bank lender is willing to provide an operating loan of $60 million (under the current operating loan, MEC is able to borrow up to $93 million at this point in time and has currently borrowed $74 million.)
Total capital requirements:
$65 million
Assume a $35 million loan from the government.
Assume $30 million from members. (This could be structured in a number of ways but there would be an expectation that the money would be returned as soon as practical with a return on the investment. There are 5.7 million members. Assume that 1 million members participate at $30 each.)
Note on a government loan:
- I understand that many people are opposed to these arrangements, I will point out that the government has spent billions on bailouts for oil pipelines, Bombardier, and the automotive sector. MEC is facing a short-term liquidity crunch and a loan (that will be repaid) to help keep Canada’s largest consumer co-operative in the hands of millions of Canadians seems reasonable.
Note on member participation:
- I think that members will participate for two reasons. First, many people want MEC to exist as a co-operative so that it will continue to be democratically controlled and will continue to direct profits back into the community through share redemption and community contributions. This first reason is my primary concern. Second, members have a financial incentive to avoid the loss of their accumulated patronage shares. Due to the accumulation of patronage returns, member shares were worth $192 million as of Feb 23rd, 2020. As an example, I checked my own balance this week and it sits at over $400. That is money that would have been paid out to me over time through share redemptions or that I could have redeemed by cancelling my membership. Based on comments on CBC news by the CEO of the acquiring company, if the transaction goes through, members are likely to lose all of that value and will permanently lose the ability to participate in any future surpluses. From a purely rational financial standpoint, a member in my position would likely loan the co-op $30 if that helped to protect over $400 in existing share value.
In conclusion:
There is a lot of information missing in the documents but I hypothesize that it would be possible to save the co-op through a combination of a bridge loan and recapitalization by the members. It is unfortunate that members were not engaged earlier in the process but I hope that someone may find a way to bring this proposal into the CCAA proceedings.
Cheers,
Steve
stevejoneshikes@gmail.com
