Guitar Center Bonds Hit a Sour Noteby
Moody’s may downgrade if music chain doesn’t extend maturities
Leveraged buyout and online rivals put pressure on cash
Guitar Center Inc. investors are fretting about its billion-dollar debt load.
Bonds issued by the biggest U.S. music retailer are hovering near record lows after Moody’s Investors Service said the chain needs to refinance this year and do a better job of curtailing leverage. If it doesn’t, Guitar Center’s credit rating could fall deeper into junk, a move likely to drive up borrowing costs.
Investors are giving Guitar Center the same rough treatment dished out to other retailers, especially the ones that loaded up on debt to pay for ill-timed buyouts. From apparel and shoes to appliances and electronics, merchants have been forced to close stores, restructure debts or file for bankruptcy as consumers increasingly shop online from their sofas instead of in stores. That trend is cutting deeply into Guitar Center’s cash flow, Moody’s said.
“We’re expecting them to refinance but not necessarily restructure,” Moody’s analyst Keith Foley said in an interview. “It’d be interesting to see if they use any of their resources to buy the bonds back at a very large discount, which by definition would be a restructuring.”
Foley’s April 12 report said Moody’s could cut Guitar Center’s B2 rating if it fails to push back debt maturities in the next two quarters. Almost half of Guitar Center’s $1.3 billion of outstanding debt is due within two years. A downgrade might be forestalled if the chain shows some momentum on revenue and earnings, Moody’s said.
Guitar Center’s senior unsecured bonds due in 2020 fell to a record low of 50 cents on the dollar on April 20, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Those notes are already rated lower, at Caa1, seven steps below investment grade.
The more senior 2019 notes, with a first-lien claim on the company’s assets, hovered near 83 cents last week, down from more than 92 cents in January. Lease-adjusted debt to earnings before interest, taxes, depreciation and amortization, a key measure of a company’s ability to pay its creditors, was about 6.3 times for 2016, according to Moody’s, which said a ratio of seven times Ebitda could trigger a downgrade.
With revenue of $2.1 billion annually, Guitar Center is the largest customer for many instrument manufacturers, Moody’s said. While online competition is a threat, musicians still flock to its more than 270 stores for instruments and accessories ranging from $300 Fender guitars to $3,300 Buffet Crampon clarinets, often conducting hands-on trials in the aisles. The lineup has included amplifiers, drums, keyboards and band and orchestral instruments, as well as recording, live sound, DJ and lighting equipment.
Bain Capital took the company private in 2007 through a $2.1 billion leveraged buyout with a combination of debt and equity. The idea was that improved operations and a private-label selection would cut expenses and boost profits, said Brian Majeski, editor of Music Trades magazine. But management didn’t anticipate the Great Recession or the full impact of cheaper instruments sold online, he said.
Ares Management LLC later acquired a 60 percent stake when it swapped $535 million of junk-rated debt for equity in 2014. Representatives for Bain and Guitar Center declined to comment, and officials at Ares didn’t respond to messages seeking comment.
Guitar Center, based in Westlake Village, California, has seen rapid management turnover, with three chief executive officers in the last two-and-a-half years alone. The current CEO, Ron Japinga, took the helm last August after serving as an executive vice president at West Marine, the boating products chain, according to a company statement.
Guitar Center has tried to diversify by offering music lessons in its stores, hoping that a service component will draw more visits. But falling prices for digital products and abundant used inventory online has slowed revenue, Majeski said.
“It’s tough to grow your business when the whole industry isn’t growing,” he said. “And Guitar Center’s got a sizable share of the market.” Still, its size and vendor support provide an advantage over small chains like Sam Ash Music Corp., non-specialists such as Best Buy Co. and online rivals.
“There’s still a reason to have stores,” Majeski said. “If you’re going to buy a $1,500 guitar, you’re not going to do it on Amazon.”