Troubles for Guitar Center

Neither a borrower nor a lender  be, for loan oft loses both itself and friend.

Polonius's famous advice to his son, Laertes, in Act I of Shakespeare's "Hamlet" has become an aphorism.  It speaks eloquently to the difficulty with which those ill-situated to afford the price of a purchase can eventually afford the repayment.

In an article dated 27 April, 2017, MarketWatch warns us on the impending downgrade of Guitar Center's bond status. 

Bonds issued by Guitar Center, the biggest retailer of musical instruments in the world, are languishing at record lows on growing concern that the company is going to be overwhelmed by its roughly $1 billion of outstanding bond debt, part of a debt burden that totals about $1.6 billion, once loans and other borrowings are included.

The article draws out GC's current troubles, it's history,  and makes a comparison to other troubled LBOs of the period immediately preceding the Great Recession.  Of course, this is relevant to the brass-playing world because GC owns Music & Arts, Giardinelli, Woodwind and Brasswind, and Music 123.  A significant segment of the retail brass market and a related segment of rentals and repairs are serviced by GC holdings.

What does a reduced bond rating mean for GC?  Prospectively, it means that the cost of borrowing will go up significantly.  Taking on more debt can be increasingly costly for GC, reducing future profits. And, that makes it harder and harder to pay down current debt.

Debt is how a leveraged buyout is born.  GC took on significant debt to be acquired by Bain Capital, and the timing of acquisition could not have been much worse.  The Great Recession (also born in debt) has caused myriad pressures:  reduced school music budgets, reduced household spending, and greatly diminished discretionary spending.  Juxtapose those pressures against competitive forces, fueled both by the wide availability of low-cost (and lower margin) imports and the juggernaut of internet commerce, and you have market forces that press down both revenues and profits. A debt-laden company cannot service its lenders. In the case of GC, one of the main lenders, Ares Management, decided to protect it's loan by trading it for equity.  It has not been enough.

The rating agency [Moody's] 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.

 That phrase, "limited revenue visibility", can mean only one thing:  the outlook for increased sales is poor.

So, GC's various holdings are looking at both weak revenue growth and strong competition in the market place.  But GC practically owns the vertical market in the US, on the large scale.  They own the largest vertical online retail web sites and the largest retail brick-and-mortar chain.  Who is the competition?  The article says Amazon, mainly.  I say, the internet, itself. 

In an earlier post I opined that Steinway might decide to sell Conn-Selmer to raise cash to ameliorate its own debt problems.  Are these two stories related? Most certainly.  GC's divisions sell Steinway's band and orchestra products.  If GC scales back or goes under, Conn-Selmer can go with it.  GC's troubles ripple throughout the music industry on every level.  Conn-Selmer would lose it's primary national dealer network if GC goes.  With GC owning such a large segment of the market, if it gets a cough, instrument makers who supply it will get a cold. 

‘The negative rating outlook also considers that a substantial amount of GCI’s debt matures within our two year rating horizon.’ Keith Foley, senior vice president, Moody’s

And, there isn't much time to turn this around.   As GC threatens to spiral down into junk bond territory, it's hard to imagine how they can turn everything around.  LBOs have used the sale of divisions to raise cash to improve the leverage position.  But each of GC's divisions face the same market pressures that the GC chain itself faces.  It's hard to see that a sale could raise the needed cash.  And as their bond status declines, leveraging their way out of this becomes harder and harder.  It seems like a death spiral.  Only robust revenues can really help, and those seem illusory at best. 

If GC were not so highly leveraged, if there was not so very much debt to service, then they could probably weather current market conditions. As it is, the current incarnation of Guitar Center was born in debt, and it might die in debt.  GC needs to find a solution to improve its debt position, and it needs to find it fast.

Neither a borrower nor a lender be....