Long Capital Structure Rehabilitation 2.0

Before we dive into the current status of Guitar Center Inc., let’s first establish that there is almost zero chance ⬆️ this kid ⬆️ ends up playing guitar when he’s older given today’s music trends. Just saying.

As everyone knows, the instrument retailer recently popped up on a variety of retail doom and gloom lists due to its over-levered capital structure and (relatively) near-term maturities. A quick flashback: the company was the target of a $2.1 billion 2007 leveraged buyout by Bain Capital. In a 2014 out-of-court restructuring, Ares Capital Management swapped its debt for equity in the company, effectively eliminating Bain from the equation and removing $500 million of debt and nearly $70 million in annual interest expense. The transaction was accompanied by a refinancing and maturity extension of other parts of the capital structure.

As a consequence of that transaction, the current capital structure stands as follows:

• $375 million asset-backed revolving credit facility due April 2019 (“ABL”);
• $615 million senior secured notes at 6.5% and due April 2019; and
• $325 million senior unsecured notes at 9.625% due April 2020.

Yes, that’s a total of $1.2 billion of debt. Despite an uptick in pre-holiday sales, the dominant narrative remains that nobody plays guitar anymore. Consequently, there hasn’t been enough revenue coming into the coffers to service this debt. You can blame Yeezy and The Chainsmokers for that. We’ve harped on about the state of music here and, in a separate guest post about Gibson Brands’ struggles, Ted Gavin of Gavin/Solmonese added some additional perspective. Longer-term trends notwithstanding, Guitar Center seeks to live another day on the back of the short-term uptick. To do so, however, it must address that debt.

On Monday, Guitar Center — with the help of bankers UBS and Houlihan Lokey and the consent of Ares — launched an exchange offer and consent solicitation related to its unsecured notes. The offer is to swap the existing $325 million 9.625% notes for $325 million of 5% cash/8% PIK notes due 2022 (along with with some warrants). Per the company’s press release, $299 million worth of holders have already agreed (92% of the issuance). This swap would save the company $13,812,500 a year in interest expense AND have the effect of pushing out the maturity for three years. Gotta love the capital markets these days.

In tandem, the company is proposing to offer $635 million of new 9.5% senior secured notes due 2021. The use of proceeds of these new notes would be to redeem the $615 million 6.5% senior secured notes due 2019. With this piece of the transaction, the company will be taking on an additional $20.35 million of annual interest expense.

Finally, the company will also refinance the $375 million ABL, extending the maturity out by 5 years.

So, if you made it this far, here’s the upshot: if these transactions are successful, the company will have availed itself of a few years to turn itself around by pushing out its debt maturities. But, it will have eliminated ZERO INTEREST EXPENSE in the aggregate. Said another way: this is a band-aid, not a solution.

All of which means that the company needs to hope and pray some rock God hits the scene and reinvigorates the market for guitars in the next two years. We’ll take the under.