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

 

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.

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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