The Debt Pyramid: How Guitar Center Paid Its April 2013 Obligation

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157745-GuitarCenterThe more you look at Guitar Center’s finances, the more you’re confronted with the dark skies of an untimely doom.

In April of this year (2013) Guitar Center had a mature PIK note due in the amount of $129.8 Million. In an interview with MMR, GC’s Executive VP of Stores, Gene Joly said that the payment went through without a hitch. I don’t know if we just have two different definitions of the word “hitch,” but to me borrowing a $100 Million dollars to make an interest payment on another loan seems like one hell of a hitch.

From reading music trade magazines, you’d think that everything with GC was just peachy. They got a new CEO. They somehow managed to pay their April bills on time. They opened some new stores. Everything was great in Mayberry. But, after some digging, it turns out that Mayberry’s future is bleak.

 

 

Put on a pretty face

In a recent interview with GC’s Executive VP of Stores, Gene Joly, MMR asked about the recent Unionization of a New York based Guitar Center store.

But, there was one gawking final addition to the article that seemed terribly out of place:

MMR: Lastly, can you comment on the status of GC’s debt repayment that was to made in April of this year?

GJ: Yes – we paid off the 129.8 Mil note in April without a hitch – exactly as we said we would – and there are no additional dept payments due until 2017.

Besides for MMR being sloppy with their editorial – “that was to made” should’ve read, “that was to be made.” And the cover indicated the article was on page 40 when it was actually on page 30. (If anyone at MMR would like to enlist my editorial services, you know where to reach me)– the article seemed to shine a rosy light on Guitar Center’s view of things.

A glaring contrast was the terse and brief MMR online-only conversation with the Retail Wholesale and Department Store Union (RWDSU). Although I am sure that MMR would’ve preferred to air both of the articles in print to give equal voice to both sides of the argument, they probably didn’t receive the union article in enough time to go to press for their July issue.

These things happen.

Oh boy was Mr. Gene Joly ever so jolly to proclaim that the April payment went “without a hitch.”

But…

In order to make the April 2013 payment of $129.8 million dollars, Guitar Center had to borrow $100 million against an “asset-based facility.” An asset-based facility is a loan where the borrower uses its assets as collateral to secure the loan. Presumably, Guitar Center’s assets are its inventory. Guitar Center doesn’t own the buildings that they use, so they couldn’t use those as collateral. That only leaves the gear hanging on their walls.

Much of what Guitar Center purchased for inventory was purchased using debt. One of the ways that they have managed to “increase” their cash for the quarter was by slowing their payments to their Fenders…I mean vendors.

“More of our vendors accepted longer payment terms.”

Payment Term: Fancy pants for “layaway”

Sooooo….. Guitar Center paid a small portion of its debt with debt that was borrowed against debt?

Guitar Center took one debt pile and moved it into another debt pile that’s stacked on another debt pile.  It’s like a Jenga tower of owing other people money. You pull one loan out from the bottom and put it on top and…

 Mitt-Romney-Jenga-Fail-GIF-At-home-with-Mitt-Romney

…well, there’s that.

What’s also worrying is the type of debt that GC has accumulated.

Anybody got a PIK?

There are many types of PIK or “Payment In Kind” instruments. Some borrowers will offer services in exchange for a loan, like a bakery paying back their loans in cupcakes – And who doesn’t love cupcakes! But, the type of PIK loan that is given to struggling companies like GC, aren’t as awesome as a giant pile of sugary sweetness.

The Roadie Rag - An EZer way to clean your instruments!

Imagine someone walks up to you and says, “Hey I’ll give you a ton of cash. Sure, I’ll charge you up the ass for interest, but I don’t need no collateral. And, you don’t need to pay me nuthin’ until…oh, let’s say five years from now.”

A person with any sense would make sure that there wasn’t a gun pointed at any important organs, turn around, and walk away.

Unless, you’re desperate.

From what I can tell, this type of PIK note sounds like the worst kind of loan in the world. Because the borrower doesn’t have any cash, the interest that’s accrued on a PIK loan is rolled back into the principal – Twice a year in the case of GC. The $129.8 Million payment that Guitar Center paid “without a hitch” in April was the PIK interest that had accrued ($189.7 million) that had been added to the principal, minus the first payment that GC made of $55 million.

A major portion of GC’s debt is in PIK notes. Because, GC doesn’t have the cash to pay for the loans that it’s taking out, it is racking up this form of unsecured debt.

Unsecured Debt = Fancy pants for “Money for nuthin.”

Metaphorically, who would give Guitar Center a credit card to pay their mortgage? Who would dare give Guitar Center so much money when they have nothing to back it up?

Well, Guitar Center. Of course!

 

You Holdin’? 

 

 We believe the company will have to borrow under its revolver to meet its financing and operating needs during 2013 and that cushion to its senior leverage covenant will likely narrow to about 10% – Reuters 2012

 

When I first read this, I didn’t get it. But, then again, I didn’t quite understand the idea of a holding company. There’s a difference between Guitar Center and Guitar Center Holdings Inc. That $100 Mill that they borrowed to make their loan payment? That money came from a revolver from their Holding company, Guitar Center Holdings. Guitar Center Holdings is the entity that owns much, but not all, of Guitar Center’s debt.

Yes, Guitar Center loaned themselves money so that they could pay interest on a loan that they already owe themselves.

Generally, businesses will create holding companies to absolve themselves of risk. Your daddy wants to start a handheld camera store chain called Holding Me. He only has a million dollars to start the business, but knows that Cousin Bob, Aunt Gertrude, and Slick Willy will all put in more money to the chain. He starts a holding company and calls it Holding Me Holdings, Inc. And, through the holding company, Bob, Gertrude, and Slick Willy can all invest into Holding Me Holdings, Inc. Which will, in turn, invest its funds into Holding Me the store. If the one of the stores fails, Holding Me Holdings Inc. can still survive and the remaining Holding Me stores will still be OK.

So, it’s not unusual for GC to create its own holding company and to have an interwoven board of directors. Remember Mike Pratt, the newly anointed CEO of Guitar Center? Well, he will also serve as the Vice President, Assistant Secretary and Director of Guitar Center Holdings, Inc.  When you hear that he’ll be working two jobs, Mr. Pratt’s $750,000 base salary with a potential annual bonus of $1.5 Million, a signing bonus of $100,000, and an inducement bonus of up to $296,500, seem like a paltry sum.

Although many holding companies will handle multiple businesses at once, Guitar Center Holdings, Inc. is different in that it only handles Guitar Center and its subsidiaries. This has been known to happen with other companies, but it’s just another thing worth noting.

Bringing in Mike Pratt was discussed in an earlier article, but what seems to come with his introduction has been an exodus of some of GC’s other senior staff. Erick Mason, there since 1996 resigned as Executive Vice President and CSO or GC holdings and GC effective April 1st. And, Warrant Valdmanis resigned back in November of 2012. It might not be a big deal, but when there are so many things changing up at one place at any time, you have to take notice.

Judging by their finances, Guitar Center is in serious trouble. Although everybody keeps trying to paint a pretty picture, things just look worse and worse year after year. While I’m always an optimist, that light at the end of the tunnel is looking more distant as time goes on.

Stay tuned. In the next few weeks, I will finish combing through their SEC filings and have more information for all of you.

 

 

 

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About the Author: Marc published his first novel Becoming in 2010. It’s a kick-ass book with monsters and dreams and stuff, and you should buy it. Since then, he’s written thousands of articles for TheToneKing.com, many of which have been picked up for circulation by manufacturers and other news outlets. His next book, Drugs and Pancakes, should be available early 2014 if his alcoholic editor can find time to work on it in-between destroying his liver and screaming about punctuation. He graduated from Roosevelt University with honors, which means that he’s not as dumb as he looks. He’s been playing guitar for over 25 years, which is almost twice as long as most of his students have been alive.

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  1. […] Well, Guitar Center. Of course! – The Tone King, July 2013 […]

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  7. ME says:

    LATEST EARNINGS ROT SHOWS A CLOSE TO 400 MILLION LOSS, majority caused by “goodwill impairment”, how does this work..?

  8. Whofarted?? says:

    The independent places in Los Angeles either have boutique places where they think they are doing you a favor by allowing you to come into the store and breathe the same air as them. Or a place with nothing but a bunch of entry level Chinese knockoffs. I think most of the little places watch what GC does and then try to stock the stuff they actually see is moving at GC but cant do it because they dont have the buying power. The poor salesman at GC are so under paid, they go through people like water through a faucet. It’s a lose-lose. Norm’s Rare Guitars in Tarzana is the only cool independent that will actually deal with you on the same gear as GC. He has treated me right many times and I try to go there whenever I can. It’s mainly just guitars and amps though. Don’t go looking for pedals or stands. And the amp stuff is pretty limited. Can’t beat the guitars though. Someone else made a good point without GC, the little guys still won’t have the selection or inventory GC has. And recently I have come across some killer deals at GC on used stuff. I waited for the stuff to sit for 90 days then threw some lowball offers and they took them. It shocked me I walked out with a Gadow American Deluxe which was never played for under $375. Or a Kendrick 2113 amp for $800. Kinda hard to beat that.

  9. Whofarted?? says:

    Lordkoo is right on the money with Fender and Gibson. There used to be a place in the West called Super Shops Automotive Performance Centers. When they bellied up in the 90’s they almost took out a bunch of long established performance brands with rich histories. Many of them filed for various types of bankruptcy and survived…barely.

  10. Gary Adams says:

    That is how Bain likes to sink a ship !!!

  11. Marc says:

    I have a GC about an hour from where I live. I go shopping there maybe once a year if we are in the area. There a couple other guitar stores near as well. When I go it there I am usually not impressed with the selection. Limited amp models and overpriced guitars. Usually a few vintage Marshall’s that are way out of my budget. There sales are ok but are similiar to other online stores. I do agree that they do have a great used selection that others don’t have. The prices are fair too. I did have a bad experience at that store and they were not very helpful. I purchased an amp online from the local store and it was already sold by somebody else. No store credit or restitution for the situation. I was not a happy camper. Totally unfair. I found another one from a smaller type guitar store payed more for it but got it fast and am happy now. Customer service can always improve and the customer comes first. I do shop around to find the best price.

  12. Jerry says:

    But when GC goes under along with whatever online service business they are affiliated with , Where do musicians go to purchase their instruments and equipment . They drove almost every Mom & Pop Music Shop out of business already . Again , You would think that a big company Like “Guitar Center” would tell there complete side of there story if this story wasn’t accurate . All they have to do is post it here . Jerry – aka – HUTCHfromBA .

  13. Steve says:

    Over the years Guitar Center has done a lot to revitalize the music industry in my opinion. Very few local stores are able to give visibility to a wide variety of musical products, have regular large contests, and have a strong internet and catalog presence.

    The local stores benefit from the visibility and display of products at GC. Their customers often come in asking for something they saw at GC.

    This all gives exposure to products that no manufacturer can do on their own. It gives musicians more choices.

    You can find the same “deals” if you look hard enough a lot of places, but what you cannot find is the huge selection of different products. Not to mention the very organized national approach to a large used inventory.

    Don’t forget the other businesses under the Guitar Center umbrella, they also do lots of good for musicians of all kinds.

  14. Jerry says:

    You would think that a big company Like “Guitar Center” would tell there complete side of there story if this story wasn’t accurate . All they have to do is post it here . Jerry – aka – HUTCHfromBA .

  15. Lord Koos says:

    I just hope when GC finally fails they don’t take Fender and Gibson with them.

    As a long-time musician I appreciate some of the services GC and Musicians Friend offer. But at the same time, I’d like to see more mom and pop stores like in the old days.

  16. TVLTNT says:

    I’ve got to hand it to you Mark. This has been an incredible learning experience as well as article on the inner runnings of GC.
    BTW the pic of Mitt totally still has me laughing my head off.
    Now as a once small town dealer myself I sort of hate to see places like Guitar Center take over.
    It sort of the huge big place that has people over the phones reading scripts when taking orders as if they were working the front counter of your favorite fast food joint these days.
    However as a plain old consumer these days I just love to get good deals like everyone else does. And thru some of the places that they own or are part of the conglomerate. I in fact have gotten some great deals that even I as a dealer wouldn’t have been able to purchase at my own dealer cost.
    So I guess my question is “Do we really want GC and it’s other holdings to fail???
    Especially when I can get what I want without even going on a long drive in my car to some place including a local GC. All I have to do is just pick the phone up or order it right online. Then basically it gets delivered to mine or your front door without even paying shipping most of the time.
    It’s like Jeff Bezo’s idea when he started Amazon.
    Then again there are still all of the nightmare stories that I have heard from others that have had not the best experience when it comes to doing business like this.
    In the meantime all I can say is get the best deals on your gear wherever you can…BUT…GC and it’s other holdings can be very helpful an mean well all at the same time too.

  17. Fyl says:

    When you carry mostly Fender and Gibson guitars some PRS
    What do you think is going to happen ? The store in Houston only has cheap Jackson’s (not USA made) . I went to GC a few years ago with $2,000 cash looking for a high end Jackson,Ibanez ESP… (for a few more bucks) no luck .

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