RadioShack cost of pre-holiday inventory poses potential restructuring trigger

By Reshmi Basu

In the wake of RadioShack posting negative USD 65m in EBITDA for 1Q14, management has been consulting with advisors on whether bankruptcy is the best near-term solution to the company’s short-circuited capital structure, said four sources familiar with the matter. Debate over how best to time a potential filing, along with last ditch efforts to pull off a capital raise from current investors, serve as variables to the board’s decision making, they added.

Among the options discussed by advisors who’ve gotten management’s ear is a recommendation that the company run a swift market check in hopes of producing a stalking horse for a 363 sale that would take place by the fall, two of the sources continued.

Timing of a Chapter 11 event is still hotly debated, as some advisors recommend the company attempt to file after the holidays, seeking to avert the headline risk a bankruptcy would present ahead of the seasonally critical period. But one concern pervading is that the retailer’s cash burn is so steep that the company simply won’t be able to buy inventory ahead of the holidays, added the third source.

To that end, most credit insurance providers have pulled coverage, said two industry sources. In response, some vendors have been turning to their own legal counsel to gauge whether to ship product to RadioShack, said the same sources and a third industry source.

“RadioShack’s future hinges on whether it can convince vendors to ship,” said the first industry source. “The rumors have been flying that RadioShack’s cash burn is getting worse and there is definitely vendor nervousness.”

Peter J Solomon and Jones Day have formal mandates as RadioShack’s financial advisor and legal counsel, respectively. But recent dialogue with other firms is due in part to some investors, particularly bondholder GSO Capital, becoming frustrated by management’s lack of responsiveness to reverse inquiries, the first source familiar said.

Late last year, some bondholders had attempted to pitch the company on a pre-packaged restructuring to preserve recovery value and liquidity. And then back in May, bondholder GSO Capital had explored whether to raise capital that could be used to take out Cerberus’ position in the retailer’s USD 250m second lien TL. Cerberus’ stake has a first-out clause in the second lien, which is also held by Salus Capital. The tranche is primed by a USD 585m GE-backed ABL due 2018.

The current group of lenders have become an impediment to management executing a turnaround plan. Executives in May tagged 1,100 stores as underperforming. But lenders won’t agree on shuttering those sites, since the properties still hold collateral value and might provide a better return in an all-out liquidation.

RadioShack’s 6.75% senior unsecured bonds due 2019 last changed hands at 43.75 versus a 41 context in early June, according to MarketAxess. The bonds traded as high as 62.5 in early January.

Meanwhile, the stock traded today at 0.81 on a market cap of USD 81.34m. That compares to a 52-week range of USD 0.80 to USD 4.36.

Also suggestive that a default is around the corner is the flattening of RadioShack’s CDS curve, according to four sources familiar with the matter. More investors are piling into the front-end of the CDS curve to hedge themselves against a potential insolvency, the sources added.

The September contract has widened to 18-22 points upfront versus 11-15 points last week, while the December contract is quoted at 36.5/39 points upfront compared to 24-27, said a trader. Six-month CDS (March 2015) is now quoted at 47.5/50.5 points upfront. Meanwhile, the differential between the 1-year and 5-year has contracted with the 1-year at 54/57 points upfront and the 5-year at 60.5/62.

In June, RadioShack was downgraded to CCC from CCC+ by S&P. The agency stated the company will hit a liquidity crisis by early next year.

As of 1Q14 ended 3 May, RadioShack’s LTM EBITDA was negative USD 240m. In the quarter, revenue dialed in at USD 737m, marking a 13.2% YoY decline on the back of a 14% same-store sale swoon.

For FY14, the issuer is projected to burn USD 407m in cash, based on negative USD 300m of EBITDA, USD 57m of cash interest, and USD 50m in capex. However, the working capital could still be booked as a gain to the tune of USD 135m, said a sellsider.

However, some investors have pegged EBITDA to fall as much as USD 400m to USD 450m, said two buysiders.

The issuer ended 1Q with USD 62m of cash and no borrowings on the USD 535m ABL. But as of 9 June RadioShack drew down USD 35m under the ABL, and management telegraphed that it plans to tap the revolver throughout the rest of the year.

RadioShack declined comment.

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