The Latest and Greatest on Guitar Center (Part 2)

Long Electronic Dance Music's Musical Awakening?

In “The Latest and Greatest on Guitar Center,” we cast some shade on the guitar retailer’s amend-and-extend transaction. We wrote,

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.

As it turns out, the company ultimately downsized the amount of 5% cash/8% PIK notes due 2022 from $325 million to $318 million which will, naturally, have the affect of...to read this rest of this a$$-kicking commentary, you must be a Member...

The Latest and Greatest on Guitar Center

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.

Is Spotify Ultimately the Death of Music?

Spotify Made Liam Gallagher Make His Own Coffee. That's Bad. 

Source: Pexels.com

It’s 2018 and that means that, unless side-tracked by $1.6b litigation, Spotify’s “direct listing” is imminent, marking the company’s latest foray screwing over (read: disrupting) professionals who endeavor to make money. No, we don’t have much sympathy for the bankers who will lose out on rich underwriting fees. If anything, the blown IPOs for Snapchat ($SNAP) and Blue Apron ($APRN) kinda made the direct listing alternative a fait accompli. Now the market will be watching with great interest to see how the stock does without the various IPO-related safeguards in place. 

The real professionals on the short end of Spotify's stick, however, aren’t the bankers but may just be the artists themselves. Recall this video from Liam Gallagher. Recall this chart highlighting the juxtaposition between digital and physical sales. But that's not all, there's this piece: it stands for the proposition that Spotify really ought to go f*ck itself. Indeed, "To understand the danger Spotify poses to the music industry—and to music itself—you first have to dig beneath the “user experience” and examine its algorithmic schemes. Spotify’s front page “Browse” screen presents a classic illusion of choice, a stream of genre and mood playlists, charts, new releases, and now podcasts and video. It all appears limitless, a function of the platform’s infinite supply, but in reality it is tightly controlled by Spotify’s staff and dictated by the interests of major labels, brands, and other cash-rich businesses who have gamed the system." To point, Spotify has perfected "the automation of selling out. Only it subtracts the part where artists get paid." There is so much to this piece. 

And then there is this piece - from a musician - which really puts things in perspective, as far as second order effects go. One choice quote (among many in this must read piece), “As a dad seeing my kids fall for an indistinguishable blob of well-coiffed brandoid bands and Disney graduates, I’m not at all shocked that amid their many fast-germinating aesthetic and creative ambitions, my own offspring have never seriously taken it into their heads to pick up an instrument or start a band. The craft of music has entirely succumbed to its marketed spectacle.” 

Against this backdrop, the distressed state of Gibson Brands Inc. and Guitar Center Inc.makes more sense. Here is Gibson Brands:

Given these disturbing downward trends, it's no wonder that Jefferies is working with the company to address the company's balance sheet and that Alvarez & Marsal LLC is helping streamline costs on the operational side. Indeed, last quarter the company negotiated some amendments (EBITDA, for one) with its lender, GSO, and even more recently negotiated, per reports, an extension of time to report financials to GSO. We can't wait to get our hands on those.

Guitar Center Inc., meanwhile, reported pre-holiday YOY increases in top and bottom line numbers, including a 1.3% increase in same store sales. Which surprised basically everyone. They have yet to release holiday numbers. They did, however, get a nice downgrade leading into Christmas. And there are debt exchanges to come in '18 for the company to manage an over-levered balance sheet unsustained by recent revenues.

Remember, Spotify did all of this with the help of $1b in venture debt (and NYC taxpayer subsidies, but we digress). Which, unless something has changed, is a ticking timebomb getting more expensive with each quarter the company fails to go public. 

Lest anyone fail to appreciate the growth trajectory of Spotify, there's the chart below to put it in perspective. 

One last note here. A few weeks ago Josh Brown wrote a piece entitled, "Just own the damn robots." If you haven't read it, we recommend that you do. The upshot of it is that the massive stock moves of the FANG stocks and other tech stocks are rooted in people's fear of being automated out of relevance. 

In that vein, maybe Spotify's imminent listing is the BEST thing that could possibly happen to creatives. Get a significant part of the company out of Daniel Ek's hands, out of the hands of the venture debt holders (assuming they have an equity kicker), and the venture capitalists. Get it in the hands of the artists themselves. Perhaps that way they can have SOME manner of control over their own commoditization. 

Where is the Restructuring Work?

Strong Voices in Finance Are Raising the Alarm

We have some very exciting things planned for the Fall that we cannot wait to share with you. Until then, we'll be channeling our inner John Oliver and spending the rest of the summer researching and recharging. Oh, and structuring our imminent ICO in a way that (i) circumvents the SEC's recent decision noting that ICOs are securities offerings and (ii) gives all current PETITION subscribers a first look at participation. Don't know what we're talking about? For a crash course, read this, this, and this. The ICO stuff is BANANAS and, yes, we're TOTALLY KIDDING about doing one. We are not kidding, however, about our planned Summer break. We'll be back in September with the a$$-kicking curated weekly commentary you've come to know and love. In the meantime, please regularly check out our website petition11.com, our LinkedIn account, and our Twitter feed (@petition) for new content throughout August. 

But before we ride off to the Lake, a few thoughts (and a longer PETITION than usual)...

There has been a marked drop-off in meaningful bankruptcy filings the last several weeks and people are gettin' antsy. Where is the next wave going to come from? A few weeks ago, Bloomberg noted that there was a dearth of restructuring deal flow and a lot of (restructuring) mouths to feed. Bloomberg also reported that, given where bond prices/yields are, bank traders are so bored that they're filling their days by Tindering and video-gaming like bosses rather than...uh...trading. (You're not going to want to thumb-wrestle millennials.) These trends haven't stopped the likes of Ankura Consulting from announcing - seemingly on a daily basis - a new Managing Director or Senior Managing Director hire (misplaced optimism? Or a leading indicator?). No surprise, then, that financial advisors and bankers are whipping themselves into a frenzy in an attempt to complement Paul Weiss as advisors to a potential ad hoc group in Guitar Center Inc. (yes, people do buy guitars online on Amazon and, yes, $1.1b of debt is a lot given declining trends in guitar playing). Even the media is getting desperate: now the Financial Times is pontificating on the "short retail" trade (firewall; good charts within) that others have been discussing for a year or so. The internet is impacting shopping malls (firewall)? YOU DON"T SAY! Commercial mortgage delinquencies are rising (firewall)? NO WAY! We've gotten to the point that in addition to having nothing to do, no one actually has anything original to say. 

That is, almost no one. After all, there is always Howard Marks of Oaktree Capital Management, who, once again, demonstrates how much fun he must be at parties. Damn this was good. Looooong, but good. And you have to read it. Boiled down to its simplest form he's asking this very poignant question: what the f&*K is going on? Why? Well, because:
(i) we now see some of the highest equity valuations in history;
(ii) the VIX index is at an all-time low;
(iii) the trajectory of can't-lose stocks is staggering, see, e.g., FAANG (though, granted, Amazon ($AMZN) and Alphabet ($GOOGL) both got taken down a notch this week);
(iv) more than $1 trillion has moved into value-agnostic investing;
(v) we're seeing the lowest yields in history on low-rated bonds/loans (and cov lite is rampant again);
(vi) we're seeing even lower yields on emerging market debt;
(vii) there's gangbusters PE fundraising (PETITION NOTE: we'd add purchase price multiple expansion and, albeit on a much smaller scale, gangbusters VC fundraising);
(viii) there is the rise of the biggest fund of all time raised for levered tech investing (Softbank); and
(ix) bringing this full circle to where we started above, there are now "billions in digital currencies whose value has multiplied dramatically" - even taking into account a small pullback.

Maybe we really should consider an ICO after all. 

And then there's also Professor Scott Galloway. He, admittedly, looks at "softer metrics" and highlights various signals that show "we're about to get rocked" in this piece, a sample of which follows (read the whole thing: it's worth it...also the links): 

We don't think he's kidding, by the way. Anyway, we here at PETITION would add a few other considerations:

1. The Phillips Curve. Current macro trends countervail conventional thinking about the relationship between unemployment and inflation/wages (when former down, the latter should be up...it's not);
2. The FED. Nobody, and we mean NOBODY, knows what will happen once the FED earnestly begins cleansing its balance sheet and raising rates; 
3. (Potentially) Fraudulent Nonsense Always Happens Near the Top. SeeHampton Creek. See Theranos. See Exxon ($XOM). See Caterpillar ($CAT). See Martin Shkreli. And note worries about Non-GAAP earnings;
4. Auto loans. Delinquencies are on the rise; and
5. Student loans. Delinquencies are on the rise.

We're not even going to mention the dumpster fire that is Washington DC these days (random aside: is anyone actually watching House of Cards or is reality enough?). 

And, finally, not to steal anyone's thunder but one avid biglaw reader added that a telltale sign of an imminent downturn is the rise of biglaw associate salaries. Haha. At least there are wage increases SOMEWHERE.

All of the above notwithstanding, even Marks cautions against calling an imminent downturn admitting, upfront and often, how he has been premature in the past. That said, nobody saw oil going from $110 to $30 as quickly as it did either. So he's right to be highlighting these issues now. At a minimum, it ought to give investors a lot of pause. And, perversely, this all ought to give restructuring professionals a little bit of hope for what may lay ahead for '18 and '19. 

Have a fun and safe rest of Summer, everyone. Don't miss us too much.