[Rich]

It was inevitable, the only question was when, and how big a cut Hoshino will have to take in the reorganization. And considering their bill is always in the 7 figures, it could hurt.


Why Guitar Center Is Going Chapter 11

And What It Means For The Industry

Guitar Center is preparing for a Chapter 11 bankruptcy filing on November 15 to restructure $1.4 billion in liabilities and renegotiate the leases on its 297 Guitar Center locations and 200-plus Music & Arts locations, according to bond holders who have reviewed financial documents but requested anonymity. A missed $45 million interest payment on October 12 was the immediate catalyst for the bankruptcy filing, but the actual cause of the financial difficulties dates back to 2007, the year the private equity firm Bain Capital acquired Guitar Center in a leveraged $2.1 billion transaction. Ever since, GC management has devoted a tremendous amount of time and energy struggling to keep current with onerous loan covenants, necessitating harsh layoffs and several ill-conceived strategic decisions.

The proposed Chapter 11 filing will be second time Guitar Center has restructured its debt since the Bain transaction. In 2013 a looming debt default enabled Ares Management Corp., Guitar Center’s largest bond holder, to take ownership in a debt for equity swap. The transaction slashed Bain Capital’s ownership position and reduced the debt burden to $1.0 billion from $1.5 billion, but still left the company highly leveraged.

While Moody’s rating service has consistently called Guitar Center’s finances “untenable” for the past five years, the company remains a financially viable retailer, that last year generated approximately $185,000,000 in EBITDA (earnings before interest, taxes, depreciation and amortization) on $2.3 billion in revenue. The company has also recently been buoyed by improved operations and a rising market, posting revenue gains in ten consecutive quarters prior to the COVID outbreak in March. Subsequent store shut downs led to a sales decline of approximately 13% in the most recent quarter, with the Music & Arts division especially hard hit by curtailed school music programs, yet cash flow was reportedly strong.

Guitar Center management is apparently hoping to bring leverage to a manageable level with another debt for equity swap that would transfer ownership to bond holders. The company’s current $1.4 billion in liabilities includes approximately $600 million in junior unsecured notes, $300 million in senior secured notes, $375 million owed to music industry suppliers, landlords, and other trade creditors, and $125 million in a revolving credit facility. A bond analyst who reviewed recent Guitar Center financials said the company would likely emerge with a more competitive cost structure if it could close underperforming stores and renegotiate leases. However, the music industry suppliers that are owed millions are bracing for a significant, but yet undetermined, financial hit. A guitar manufacturer owed a seven-figure amount said, “We’re expecting to take a serious haircut in the reorganization.”

Guitar Center’s imminent bankruptcy filing is essentially the failure of a high-stakes bet on rapid sales growth. The $2.1 billion Bain paid for Guitar Center in October of 2007 represented a rich valuation: 23 times earnings or nearly twice the multiple of big box chains like Bed Bath & Beyond, Dick’s Sporting Goods, or Best Buy. The high price was based on the assumption that Guitar Center revenues would continue growing from $2.0 billion in 2007 to around $3.0 billion by 2012. It was also underpinned by a belief that Bain’s managerial magic could ratchet up Guitar Center’s margins and overall profitability.

Much of the failure to achieve these optimistic goals could be chalked up to the 2008 financial crisis and the ensuing economic stagnation. Bain management could be forgiven for failing to anticipate these events. However, their purchase price was sufficiently lofty, it made no allowance for even the slightest setback. A much milder recession could have pushed Bain’s investment into the red. On the operational front, however, Bain’s “improvements” didn’t deliver as promised. The attempt to reduce overhead expense by integrating the Musician’s Friend mail order division into the Guitar Center organization backfired, with the unfortunate result that Musician’s Friend revenues declined at a time when most other online merchants were posting robust growth. Trimming operating expenses at the store level and on the backs of the front-line sales staff took a heavy toll on morale and customer service, and even prompted an unwanted unionization drive. Eliminating negotiated sales in the midst of a recession alienated customers and created opportunities for independent merchants. Finally, Bain failed to anticipate how the rise of e-commerce had diminished the power of Guitar Center’s brick and mortar stores. Reflecting these trials, the company cycled through five CEO’s over the past decade.

By virtue of its size and market clout, Guitar Center has been the company many in the industry love to hate. Independent retailers resent the way GC uses its scale to negotiate better pricing, while manufacturers gripe endlessly about the retailer’s demand for return privileges, promotional allowances, and other forms of monetary support. However, with its network of well-appointed stores, efficient distribution system, and potent marketing capabilities, Guitar Center remains a vital factor delivering all things musical to the general public. The industry would be diminished in its absence.

Brian T. Majeski
Editor

 

[tobe]

Strange times for sure.

I cannot help but wonder if GC is just another foot-note in the changing purchasing patterns of the last 20+ years. The GC stores in my neck of the woods mostly have the inventory that moves quickly, and not much that a more experienced player would care for. Couple that with their lack of depth in inventory of the hardware/equipment side of things, there really is no reason for me to go there. Once the price haggling went away, so did I, LOL. Their financing options is attractive though. In all seriousness though, 20+ years ago people were way more hesitant to purchase a guitar online/mail order, but no days it seems like its the norm. Amazon having any part that I need within a few days, with free shipping, is a game changer that the brick 'n mortar stores cannot compete with, especially with Amazon's massive logistic channel. I wonder what the consumer landscape will look like in another 20 years? Will there be another massive paradigm shift, or will online sales become the main method of consumer spending? Thanks for sharing!

 

[jono]

Guitar Center, to a Brit is an interesting concept, we’ve got a few chain stores but nothing of the size that GC grew to. I’m not surprised it got caught out by trends and global financial issues, it sounds like it was run right at the edge of its viability anyway, and with a few bumps in the road.

My pet peeve with big box stores (here in the U.K.) is that they are typically staffed by people interested in being a rock star rather than being in customer service, which means that typically I’d rather not deal with anyone at all, than deal with the guy who’s just working there until he’s the next big thing...

 

[Rich]

Guitar Center’s $2.0 Billion Education

Brian T. Majeski
Editor
Music Trades

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.

 

[jono]

Thanks for posting Rich, it's good to hear that the company is going to survive

However...

The fact the GC survived at all is a testament to the underlying strength of the business model and the ability of the staff.

The internet tends to describe them as bitter, good for nothing slackers who do nothing but sit around all day playing the guitars instead of selling them!

I'm sure they're not that bad though !!!

 

[Rich]

When I translate to me it means the suits that make the business decisions to try and make it to the next renegotiation in better position than the last. Not the guys behind the counter. Although i can personally say I've always liked the guys in my local.