Tuesday, October 02, 2012

How Private Equity Works (Bain Capital, etc.)

 I'm no financial expert and can barely read balance sheets.  But it seems to me in the case of Guitar Center,  an underperforming company was loaded with debt, and was sucked dry.  Per dailykos.com, it is struggling to make its interest payments.

Beginnings:
The Guitar Center story began in 1959 when Wayne Mitchell purchased a small appliance and home organ store in Hollywood, California. By 1961, he'd changed the name of the company to The Organ Center. In 1964, Joe Banaran, President of the Thomas Organ Company, approached Wayne in search of an outlet to sell a new line of guitars and amplifiers, called Vox.

The timing was right, and Wayne saw the chance to seize a new retail opportunity. He was in the midst of relocating his original Hollywood Organ Center location to a new site, and he agreed that rather than closing down the old store, he would stock it with Vox guitars and amplifiers. Wayne named the store The Vox Center. By the late sixties, it had become evident that the future of musical instrument retailing lay in guitars and amps, not organs, and The Vox Center was re-christened The Guitar Center.

Bain Capital buys Guitar Center, June 2007



(Reuters) - Guitar Center Inc. GTRC.O said on Wednesday it agreed to be acquired by private equity firm Bain Capital Partners LLC for about $1.9 billion plus assumed debt.
Under the terms of the deal, Guitar Center stockholders will receive $63 in cash per share, marking a 26-percent premium over its closing price on Tuesday, the musical instruments retailer said in a statement.

As of March 31, the company had 30.17 million diluted shares outstanding, as reported in its first-quarter earnings report.

Total value of the transaction, expected to close in the fourth quarter, is approximately $2.1 billion including assumed debt, the company said.
Why was Guitar Center a target?
Credit Suisse analyst Gary Balter said the company "seems like the perfect LBO."
"They have a dominant retail position in a high service business yet significantly under-earn other high service oriented retail segments," Balter wrote in a research note following Guitar Center's announcement.
This means that their dominant position in the music and arts business could possibly be converted into higher earnings and margins, and hence value. 

Guitar Center's 2006 annual report is available on Edgar (scroll down).

According to the report, Guitar Center had sales of $2.03 billion, long-term debt of $103.1 million, net interest expense of $8.45 million, and EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization)  of $86.2 million.





Year ended December 31,



2006

2005

2004

2003

2002



(in thousands, except per share and operating data)

Income statement data:











Net sales

$
2,029,966

$
1,782,499

$
1,513,172

$
1,275,059

$
1,100,889

Cost of goods sold

1,435,963

1,262,097

1,087,899

931,014

810,474

Gross profit

594,003

520,402

425,273

344,045

290,415

Selling, general and administrative expenses

466,555

388,380

317,585

271,996

236,537

Goodwill impairment

80,160





Operating income

47,288

132,022

107,688

72,049

53,878

Interest expense, net

8,448

7,339

5,390

12,540

13,077

Gain on sale of property

2,115





Income before income taxes

40,955

124,683

102,298

59,509

40,801

Income taxes

40,531

48,005

38,873

22,649

15,545

Net income

$
424

$
76,678

$
63,425

$
36,860

$
25,256

Diluted net income per share

$
0.01

$
2.67

$
2.29

$
1.47

$
1.09

Diluted weighted average shares outstanding (1)

28,402

29,846

28,976

26,119

23,130

Operating data:











Guitar Center net sales per gross square foot (2)

$
580

$
599

$
585

$
560

$
546

Net sales growth

13.9
%
17.8
%
18.7
%
15.8
%
16.0
%
Increase in Guitar Center comparable store sales (3)

3.7
%
5.8
%
9.7
%
6.9
%
6.5
%
Guitar Center stores open at end of period

198

161

136

122

108

Ratio of earnings to fixed charges (4)

2.6x

6.5x

6.6x

3.5x

2.8x

Net cash provided by operating activities (thousands)

$
21,583

$
65,710

$
85,506

$
58,005

$
12,248

EBITDA (thousands) (5)

$
86,180

$
161,022

$
129,992

$
92,669

$
70,738

Balance sheet and other data:











Net working capital

$
326,539

$
287,098

$
269,859

$
198,713

$
110,825

Property and equipment, net

201,986

149,209

97,349

93,347

89,702

Total assets

927,478

780,190

574,593

460,871

452,399

Total long-term and revolving debt (including current portion)

103,134

132,266

100,000

100,000

149,590

Stockholders’ equity

542,737

404,817

306,682

214,171

154,928

Capital expenditures

84,417

75,493

26,151

24,245

26,309




Fast forward five years.  The annual report for 2011 reports sales of $2.08 billion, long-term debt of $996.8 million (Guitar Center) and $1.56 billion (Holdings).   The EBITDA is $197 million.  What is the problem?  Guitar Center is drowning in its interest payments.

Financial data of Holdings, except where otherwise indicated




















Successor Predecessor(1)
Period from
October 10,
2007 to
December 31,
2007(2)
Period from
January 1,
2007 to
October 9,
2007(2)
Year ended December 31,
(Dollars in millions)
2011 2010 2009 2008
Income statement data:
Net sales
$ 2,082.6 $ 2,010.9 $ 2,004.2 $ 2,228.6 $ 631.5 $ 1,620.0
Gross profit
635.1 605.9 589.4 631.0 174.8 461.6
Operating income (loss)
Guitar Center
(96.8 ) 59.7 (87.9 ) (202.2 ) 26.2 24.5
Holdings
(97.1 ) 59.7 (87.9 ) (202.2 ) 26.2
Net income (loss)
Guitar Center
(153.7 ) (8.9 ) (147.6 ) (185.3 ) (0.2 ) 6.3
Holdings
(236.9 ) (56.4 ) (189.9 ) (219.5 ) (8.0 )
Balance sheet data (at end of period):
Total assets
Guitar Center
1,883.7 2,115.6 2,109.7 2,308.7 2,670.4
Holdings
1,859.1 2,120.7 2,140.1 2,318.1 2,702.2
Long-term debt
Guitar Center
996.8 997.5 998.1 1,020.3 1,104.9
Holdings
1,561.5 1,562.1 1,490.9 1,450.4 1,479.9
Other financial data:
Depreciation and amortization
106.2 104.9 113.8 137.0 24.4 34.8
Capital expenditures(3)
57.3 47.9 45.2 39.4 16.5 50.8
Adjusted EBITDA(4)
196.9 184.3 179.3 191.7 55.9 119.0
Total Debt
Guitar Center
997.5 998.1 1,018.9 1,028.9 1,107.0 160.7
Holdings
1,562.1 1,562.8 1,511.6 1,458.9 1,482.0
Other operating data:
Increase (decrease) in Guitar Center comparable store sales(5)
3.7 % (0.1 )% (11.9 )% (5.3 )% 1.6 % 0.7 %
Guitar Center stores at beginning of period
214 214 214 214 213 198
Opened Guitar Center stores
10 1 15
Closed Guitar Center stores
Guitar Center stores at end of period
224 214 214 214 214 213
Music & Arts stores at beginning of period
101 97 97 101 98 97
Opened Music & Arts stores
3 4 2 2 3 9
Closed Music & Arts stores
2 2 6 8
Music & Arts stores at end of period
102 101 97 97 101 98


What is Holdings?  A footnote explains:

On October 9, 2007, Guitar Center merged with an entity substantially owned by affiliates of Bain Capital. In connection with the merger, Holdings acquired all of the outstanding capital stock of the predecessor for aggregate cash consideration of approximately $1.9 billion. Holdings, which is substantially owned by affiliates of Bain Capital, owns 100% of the stock of Guitar Center.  
Bain Capital and Holdings must have loaded up Guitar Center with debt fairly quickly - Moody's downgraded its bonds to junk in October 2007.(In October 2006, Moody's rated Guitar Center as Ba2. After Guitar Center was taken over by Bain in June 2007, Moody's rated it B2 in October 2007, and supposedly Caa2 in November 2010.)