Re: GC Files Chapter 11, Again.
Guitar Center’s $2.0 Billion Education
Brian T. Majeski
Guitar Center declared Chapter 11 on November 13, ending months of speculation about the retailer’s survival. A trip to the bankruptcy court is never cause for celebration, but in the case of Guitar Center, it’s actually good news. The pre-negotiated deal with creditors allows GC to shed nearly $800 million in debt, putting it on a path towards solvency. Private equity firms Ares Management, Brigade Capital Management, and Carlyle Group will also invest $165 million in equity capital to further shore up the balance sheet. In other positive news, GC will pay its industry vendors in full, no doubt because otherwise, it would head into December with poorly stocked stores. The fact that GC has retained a consultant to “evaluate” real estate options suggests landlords may not fare as well.
The approximately 300 Guitar Center locations, 200 Music & Arts locations, and the Musician’s Friend and Woodwind & Brasswind websites generated about $2.3 billion in revenues in 2019. In a prepared statement, CEO Ron Japinga indicated that the Chapter 11 restructuring positions Guitar Center to “invest in operations,” and “better serve its customers.” He also noted that prior to the COVID pandemic, the company had racked up ten consecutive quarters of sales growth. Here’s hoping he’s right. While GC will never win a popularity contest with independent retailers, the company’s national footprint and extensive promotional activities play an important role in raising the visibility of music products. For that reason, its survival is a net positive for the industry.
However, the fact that the survival of Guitar Center was ever in doubt is a scathing indictment of thirteen years of private equity stewardship. Highlights of the Bain Capital and Ares Management record include flatlining revenues, $2.0 billion in capital destroyed, and a succession of morale crushing “restructurings.” The fact the GC survived at all is a testament to the underlying strength of the business model and the ability of the staff. It could easily have been a casualty like other highly leveraged chains, including Toys R Us, Payless Shoes, Gymboree, and Radio Shack.
To recap the sorry story: Bain Capital acquired Guitar Center in late 2007 for $2.1 billion, putting down $600 million of its own money and borrowing the rest. In the prior year, with 198 Guitar Center stores and 97 Music & Arts locations, the company had a net profit of $80 million on revenues just north of $2.0 billion. Finances were rock solid with long term debt at just $1.4 million and $100 million owed on a revolving credit line. Bain’s ambitious plans to revamp the retailer with high margin private label brands, the elimination of negotiated sales, and improved inventory management were quickly derailed by the 2008 financial crisis. What followed was a painful seven-year slog marked by layoffs, three different CEOs, and declining revenues.
Unable to meet looming bond payments in 2014, Guitar Center went through a privately negotiated bankruptcy, otherwise known as a “reorganization.” Under the complex transaction, Ares Management took over Bain Capital’s ownership stake and debt was trimmed to $1.0 billion from $1.5 billion. The deal headed off liquidation, and by cutting interest payments, provided some financial relief. However, it still left GC saddled with an unmanageable debt burden, necessitating another “reorganization” in 2018. But for the COVID pandemic, GC might have limped along for several more years, but even under the best of conditions, operations would never have been able to generate the cash required to paydown $800 or $900 million in bonds.
Guitar Center’s accrued losses over the past thirteen years can be attributed to overly optimistic forecasts, the financial crisis, increased online competition, and the COVID pandemic. But we think the fundamental problem lies with the richly compensated financial engineers who leveraged the company to the hilt in hopes of selling it later at a handsome profit. The debt burden they incurred effectively handicapped management. Energy that could have been expended on creating better retail operations was diverted to the pressing task of managing the razor thin margin separating cash flow and interest payments—something akin to trying to win a marathon while hauling a 75-pound weight.
Successful businesses thrive by delivering a desirable product or service at a compelling price and financial management exists to support the basic mission of serving the customer. For the past thirteen years Guitar Center’s owners had this formula exactly backwards. In their world, the primary role of the retail operations was to meet outsized interest payments.
Between 1964 and 2007, Guitar Center had an extraordinary run, expanding from a single location in Los Angeles to the industry’s first national chain. A talented team with a “do whatever it takes mentality,” committed to creating the best-looking stores, offering the best deals, and making happy customers drove the success. With a de-leveraged balance sheet and a chastened ownership, perhaps Guitar Center can relearn some of the lessons that made the company successful in the first place. But, if they do, it will have been an awfully expensive education.