Barnes and Mullins

Barnes and Mullins

Moody’s hammers Guitar Center – is the end in sight?

Guitar Center, the giant US retail chain with over $1 billion in debts, has suffered another blow with its bonds nearing record lows. Meanwhile, Bloomberg Markets has reported that Moody’s Investors Service says the chain needs to refinance this year and do a better job of curtailing leverage. ‘If it doesn’t, Guitar Center’s credit rating could fall deeper into junk, a move likely to drive up borrowing costs.’

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Guitar Center’s problems are threefold. It is suffering intense competition from efficient online operations, led by the impressive Sweetwater and Amazon, and it is also suffering from a general downturn in US retail sales which has afflicted many US retail sectors, not just MI. But the worst problem facing the chain is the massive debt burden brought about by the 2007 leveraged buyout and subsequent manoeuvrings.

‘We’re expecting them to refinance but not necessarily restructure,’ Moody’s analyst Keith Foley said. ‘It’d be interesting to see if they use any of their resources to buy the bonds back at a very large discount, which by definition would be a restructuring.’

According to Bloomberg: ‘Foley’s 12 April report said Moody’s could cut Guitar Center’s B2 rating if it fails to push back debt maturities in the next two quarters. Almost half of Guitar Center’s $1.3 billion of outstanding debt is due within two years. A downgrade might be forestalled if the chain shows some momentum on revenue and earnings, Moody’s said.

‘Guitar Center’s senior unsecured bonds due in 2020 fell to a record low of 50 cents on the dollar on April 20, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Those notes are already rated lower, at Caa1, seven steps below investment grade.

‘The more senior 2019 notes, with a first-lien claim on the company’s assets, hovered near 83 cents last week, down from more than 92 cents in January. Lease-adjusted debt to earnings before interest, taxes, depreciation and amortization, a key measure of a company’s ability to pay its creditors, was about 6.3 times for 2016, according to Moody’s, which said a ratio of seven times Ebitda could trigger a downgrade.’

US analysis site says: ‘Moody’s is concerned that the company will not generate enough free cash flow in the next 12 to 18 months to reduce debt and improve leverage, which will require that its strategic moves to boost revenue and earnings succeed. The company’s lease-adjusted debt-to-EBITDA coverage for 2016 was about 6.3 times, which is just below the 7.0 times that Moody’s expects would trigger a downgrade. The rating agency is further concerned about the limited revenue visibility in the musical instrument space and the company’s “only very modest free cash flow potential,” which makes the company vulnerable to a rise in leverage.’

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The knock-on effects of potential Guitar Center closures could be dramatic for the industry as a whole. The retailer is the single largest customer for many MI manufacturers. A complete closure could be catastrophic while even a reduction in its 270 stores across the USA could have dramatic consequences for the sector as a whole.

Mitt Romney’s former private-equity firm, Bain Capital, took Guitar Center private in 2007 through a $2.1 billion leveraged buyout which was predicated on cost savings and increased profit margins which have failed to live up to expectations. The buyout left GC with $1.6 billion of high-yield debt.

Guitar Center’s problems highlight not only difficulties in MI and retail generally, but also fundamental flaws resulting from the leverage buyout craze that swept the USA in recent decades. Other casualties being named include icons like Neiman Marcus and iHeartMedia, the US’s largest chain of radio stations, itself the result of a leveraged buyout of Clear Channel Communications.

Bloomberg, meanwhile, also revealed that Guitar Center has seen rapid management turnover, with three chief executive officers in the last two and a half years. Bloomberg adds that no one from Ares, Bain of Guitar Center would comment on the situation.

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