RadioShack’s Tussle With Its Lead Lenders Can Leave The Company Bankrupt

Recent allegations of covenant breaches by its key lenders has added yet another roadblock to RadioShack’s (NYSE:RSH) turnaround path. The company is already plagued by an eroding top line growth, declining gross margins, high inventory levels, a string of debt maturities and declining cash reserves. The news has shattered investor confidence further as it comes right before the holiday season, when retailers generate a significant portion of their annual revenue. The RadioShack stock is down approximately 15% since the news of the company receiving the notice from Salus Capital and Cerebus Capital Management hit the market.

Allegations of Defaulting On the $250 Million Loan

Salus Capital Partners and Cerberus Capital Management have accused RadioShack on defaulting on the $250 million loan provided by them a year ago, when it secured a separate credit line in October this year (explained in detail below). As per RadioShack’s 8K filing on December 1, in addition to asserting events of default, the notice of default by the lenders also demands the immediate payment in full by the company of the $250 million term loan outstanding under the SCP Credit Agreement, together with all accrued and unpaid interest thereon and any other amounts owing to the SCP Lenders thereunder.

According to a person familiar with the matter, Salus and Cerberus are concerned the company lacks a viable turnaround plan, and have exercised their right to block store closures as they try to influence the company’s business plans, reduce their exposure or improve their position in the event of a bankruptcy. ^[1] Earlier this year, RadioShack had to retract its plan to close around 1,100 stores unable to reach an agreement to do so with its lead lenders Salus Capital Partners and GE Capital. In various negotiations, the lenders have asked for cash, early repayment of some of the loan or more restrictive debt agreements in exchange for their consent to store closures, terms that were not acceptable to RadioShack. The company believes that that the term lenders seek only to advance their particular interests at the expense of all other RadioShack stakeholders.  In sum, management believe these creditors will oppose any common sense business move requiring their consent unless RadioShack agrees to their exorbitant demands.

Salus doesn’t have a strong position in the pecking order for repayment in the event of a debt restructuring. Salus and Cerberus have a first claim on certain assets such as real estate and intellectual property, but Cerberus has the right to the first $100 million recovered from that collateral. ^[2]

RadioShack disagrees with the allegations, believes that the claims are wrong and self-serving, and intends to vigorously contest them. (Read Press Release) RadioShack executives plan to negotiate with the lenders toward a so-called “forbearance” agreement not to take action on the alleged defaults. The company plans to continue seeking an amendment to its credit agreement and ask Salus Capital Partners LLC to renegotiate terms of its loan to allow it to close more under-performing stores, according to two people with knowledge of the matter. RadioShack also plans to move forward with recapitalization deals to which it has agreed with its other creditors, including a rights offering and a debt-for-equity conversion, which are set to take place in the beginning of 2015. Negotiations with bondholders who own $324.8 million of the company’s 6.75% notes due May 2019 would resume shortly after the recapitalization is completed. ((RadioShack Said to Seek Lender Deal After Default Claim, Bloomberg, December 6, 2014))

Restructured Financial Deal Signed In October 2014

RadioShack announced a new financial deal in October this year, which by design will give a controlling stake of the company to two hedge funds – Standard General and LiteSpeed Management. Standard General and certain other investors have replaced GE Capital as the lead lender under RadioShack’s senior secured asset based credit facility. Restructuring a portion of RadioShack’s debt, the agreement provides the company with $120 million in additional capital as the investors, led by Standard General and LiteSpeed Management, take over a revolving line of credit. The deal was meant to give RadioShack sufficient credit capacity to fund its inventory build for the upcoming holiday season and prevent it from going into bankruptcy.

While the new financial agreement equips RadioShack with the much needed capital to run the company, it gives Standard General and LiteSpeed Management the right to convert the loans into equity in the coming months, if Radioshack achieves certain financial goals, and nominate four members of a reconstituted seven-member board of directors. The conversion is expected to give Standard General and Litespeed Management a controlling stake in RadioShack. The percentage of equity securities that Standard General and other investors will own will depend upon the level of participation of existing shareholders in the rights offering. Existing RadioShack shareholders will have the right to purchase equity securities at a price of $0.40 per common share equivalent.

RadioShack has been trying to reinvent its retail strategy for years. If the company is unable to reach a deal with its lenders, it will have to file for bankruptcy next month. At the end of Q2 2015, it had cash and cash equivalent of $31 million and total debt of $658 million.

Our price estimate of $0.86 for RadioShack is now at a significant premium to the current market price. We will update our model after the Q3 2015 earnings release on December 11th.

See our full analysis for RadioShack

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1. RadioShack Again Denies Defaulting On Loan, The Wall Street Journal, December 8, 2014 [↩]
2. RadioShack, Lenders At Odds Again, The Wall Street Journal, December 2, 2014 [↩]