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.)