RadioShack Tracks Kodak With 80% Default Odds: Corporate Finance
Derivatives linked to RadioShack Corp. (RSH) debt imply the retailer has an 84 percent chance of default within five years, a level Eastman Kodak Co. (EKDKQ) and AMR Corp. reached within six months of filing bankruptcy protection.
Credit-default swaps on the Fort Worth, Texas-based electronics chain’s debt have been rising since January, when they indicated a 50 percent default risk, jumping after the company reported a second-quarter loss last week. Kodak hit the 84 percent level on July 18, 2011, six months before it filed.
Investors are concerned RadioShack may burn through its $517.7 million of cash as competition from online and discount retailers such as Amazon.com Inc. to Wal-Mart Stores Inc. squeeze margins at electronics chains including RadioShack and Best Buy Co. RadioShack is concentrating on low-margin mobile phones, prompting Standard & Poor’s to downgrade it yesterday to B-, six levels below investment grade, with a negative outlook.
“The market seems to be saying it is surprised that the company has continued to survive,” said Melissa Weiler, managing director at Crescent Capital Group LP, an alternative- credit asset manager that oversees about $10 billion. “RadioShack seems to be one of a few dinosaurs remaining out there,” she said in a telephone interview from Los Angeles.
“RadioShack has a solid balance sheet and cash flows this year,” spokesman Eric Bruner said in an e-mail. “We have ample options available to refinance about half of the $375 million due in August 2013. RadioShack had $518 million in cash on hand at quarter-end and total liquidity of more than $900 million.”
Swaps on Best Buy debt surged to the highest on record last week after the world’s largest electronics retailer cuts jobs and attempts to thwart so-called showrooming, when customers test gadgets in a store and then buy them online, by adopting minimalism rather than its traditional big-box approach.
“RadioShack seems to be quite similar, though much smaller, to the situation we saw with Best Buy, but I think Best Buy has a more appealing business plan and prospects,” Weiler said.
RadioShack swaps jumped 28.3 percentage points this year to a mid-price of 38 percent upfront yesterday, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That means investors pay $3.8 million initially and $500,000 annually to protect $10 million of the company’s debt for five years. That’s up from $966,000 upfront in January, and compares with $1.5 million upfront for contracts tied to Best Buy.
RadioShack is focusing on mobile phones, which appeal to “very price-sensitive consumers,” according to Bonnie Baha, head of global developed credit at Los Angeles-based DoubleLine Capital LP, which oversees $40 billion. “When you have a consumer who is very dependent on price, with low margins, it’s tough to manage a business and grow to prosperity,” she said.
The company began as an electronics parts supplier in Boston and grew after it was purchased by leather-crafts chain Tandy Corp. in 1963, according to business historian Hoovers Inc. The company expanded as vacuum tube electronics were replaced by solid-state technology and got a boost from the popularity of citizen-band radios in the 1970s.
“Solid-state sold to the masses changed their business forever, and they didn’t get the joke,” Baha said. “A lot of these brand names have had the disadvantage of being around long enough to remember what it was like but not being able to act fast enough to see what it would become.”
The story is similar to that of Kodak, which filed for bankruptcy in January after it failed to commercialize the digital technology it invented. Instead, it focused on printers.
“That was the point at which the company could not recover because they chose a product line that was competitive, low margin,” and “not only did they bet on a losing horse, they doubled down on the bet,” Baha said.
Swap tied to Kodak reached levels that implied an 84 percent chance of default in five years on July 18 last year, six months before it filed for Chapter 11 protection, and American Airlines parent AMR’s credit-default swaps passed that level on Sept. 22 before it filed on Nov. 29.
Even as swaps tied to their debt soared past levels implying more than 80 percent odds of default, companies from Sears Holdings Corp. to Clear Channel Communications Inc. continue to pay debt holders.
Contracts on Sears reached a record 42.5 percent upfront in January after people familiar with the situation said suppliers were unable to get loans from CIT Group Inc., before falling to 26.5 percent last week, implying a 68 percent risk of default. Swaps on Clear Channel surged to 54.5 percent yesterday, indicating an 84 percent chance of default, the data show.
RadioShack’s $324.8 million of 6.75 percent notes due May 2019 have dropped 9.5 cents on the dollar since July 25, when the company reported a quarterly adjusted loss of 20 cents a share, compared with the average analyst estimate projecting a profit of 4 cents, according to data compiled by Bloomberg.
Net loss for the period was $21 million, compared with a profit of $24.9 million a year earlier. The company suspended its dividend to preserve cash.
The May 2019 notes fell to 65 cents on the dollar yesterday to yield 15.18 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The bonds are down from 90.25 cents in January.
At the end of last quarter, RadioShack had $517.7 million in cash and $392.5 million available under an asset-based revolving credit facility, and $679 million of debt, according to a July 25 regulatory filing.
The credit market is reflecting “concerns that liquidity will tighten up on continued weak results,” according to JPMorgan Chase & Co. high yield consumer analysts Carla Casella and Paul Simenauer. “The earnings problem is all margin,” they wrote in a note dated July 26.
“The concern over the next six months is whether vendors tighten terms on the company because of less liquidity cushion,” they wrote. So far that hasn’t happened, they wrote.
Gross margin, the percentage of sales left after costs of goods sold, narrowed to 37.8 percent in the second quarter from 45.9 percent a year earlier, Bloomberg data show.
“We were disappointed in our gross margin rate performance, as the initiatives we have under way have not yet generated enough momentum to improve the trend,” Jim Gooch, RadioShack’s president and chief executive officer, said in a July 25 earnings statement.
Selling more smartphones, including Apple Inc.’s iPhone, contributed to the decline in gross margin. It will continue to pressure margins in the third quarter and “to a lesser extent” the fourth, Gooch said in a conference call to discuss the quarterly results with analysts and investors that day.
“It will be very difficult for the company to improve its gross margin in the next year, given the changing industry dynamics and mobility accounting for more than 50 percent of sales,” S&P analysts Jayne Ross and Charles Pinson-Rose wrote in the note yesterday.
RadioShack’s credit-default swaps are the widest of the group of U.S. retailers tracked by Bloomberg, and the 11th widest of global credit-default swaps, trailing Energy Future Holdings Corp., Caesars Entertainment Operating Co., and Clear Channel, Bloomberg data show.
Fitch Ratings downgraded RadioShack’s issuer default rating to CCC on July 25, citing a “lack of stability” and “no apparent catalyst” for improvement. Long-term prospects for the mobility segment are “uncertain,” analysts Philip Zahn and Monica Aggarwal wrote.
They estimated RadioShack would be worth about $660 million in liquidation, giving a recovery value of as little as 91 cents on the dollar for its $450 million asset-based revolving line of credit and 11 cents on the dollar for its $700 million of bonds.
RadioShack’s net cash has declined in each of the last three quarters, falling a cumulative $150 million, Bloomberg data show.
“There’s a lot of concern from a viability of business model,” Joscelyn MacKay, a credit analyst at Morningstar Inc. in Chicago, said in a telephone interview. RadioShack’s burn rate over the past six months indicates that it’ll probably run through its cash by the time its $375 million of convertible notes mature in August 2013, she said.
“In a downside scenario, you could see a potential that they won’t have enough revolver capacity or cash to finance the convert, and they’ll have to go to the public market,” she said. “That’s too much of a question mark for us.”
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