Circuit City Unlikely to Successfully Emerge from Bankruptcy

Nov.10.08 | About: Circuit City (CCTYQ)

Several months ahead of my earlier prediction of the company falling sometime after the holiday shopping season, Circuit City (NYSE:CC) filed for bankruptcy this morning:

(From the WSJ): "Troubled electronics retailer Circuit City Stores Inc. filed for Chapter 11 bankruptcy Monday in an effort to stay ahead of lenders owed $898 million.

With going-out-of-business sales already in full swing at about 20% of its outlets, the nation's second-largest consumer electronics chain by revenue says it has an immediate need for financing.

The company cited erosion of vendor confidence and consumer retreat in the face of the global economic crisis for the bankruptcy filing.

Bruce Besanko, chief financial officer of the chain, said in court papers that the Chapter 11 filing is an effort to salvage a restructuring effort that has already cost thousands of jobs. An expected $75 million tax refund has yet to arrive, leaving the cash-strapped retailer struggling to make sure it has goods for the holiday season, Mr. Besanko said in a court filing.

Circuit City will ask the U.S. Bankruptcy Court in Richmond, Va. for permission to roll its existing bank debt into a Chapter 11 loan, in order to free up cash to stock the shelves, court papers say.

In what is becoming a familiar pattern in retail bankruptcies, the company's existing lenders, led by Bank of America Corp., will finance the bankruptcy, as long as the new loan they make is used to pay off their existing loans.

The lenders have agreed to loan Circuit City $1.1 billion to keep the retailer's doors open through the holiday season. The amount available under the bankruptcy loan will be cut to $900 million on Dec. 29.

With money tight, banks find themselves stuck bailing out distressed companies, instead of simply handing off the troubled credits to new lenders, as they were able to do before the credit crunch.

Circuit City cited "the widespread liquidity crisis among all major banks and other lending institutions throughout the country," in arguing for court approval of the Chapter 11 loan. The company has two years of losses under its belt, including a $404 million loss for the six months ended in August.

Circuit City's Canadian operations are being placed under the protection of insolvency courts as well, court papers say."

The problem here is that Circuit City is virtually guaranteed to lose money this holiday season, and has proven themselves incapable of making money in a market that is still profitable (even now) for all of its competitors and has arguably been one of retail's bright spots this year. The problem has never been debt related it's been the way the company operates, as I've said dozens of times before the company hasn't been able to make money selling virtually the same products, at the same prices as its competitors.

Furthermore CC isn't filing bankruptcy in order to free up cash to invest into improvements into the business, they're filing bankruptcy so they can afford to stock the shelves for the coming holiday season. A company that needs to file bankruptcy just to raise the cash to buy products, isn't likely to have enough resources left over to make key investments into the company. This filing is more about buying time and hoping something works out, than it is about finding a way to survive while a turnaround plan is implemented.

Extending Circuit City new financing so they can continue to operate, ease pressure from creditors, vendors, etc, is basically prolonging the inevitable, unless fundamental changes are made to the way the company operates.

I.e. the company's creditors have agreed to finance hope and another round of losses, as it doesn't look like Circuit City is going to be doing anything different this coming holiday season that will allow it to turn a profit.  

In the end the new loans granted to Circuit City are probably more about buying time for its lenders with respect to the credit crunch, then they are about believing the company has a legitimate shot at survival.

If the company continues to lose money on a go-forward basis (and all signs point to this happening), then it stands to reason that the company won't be able to successfully emerge from bankruptcy.

View the full CC chart at Wikinvest

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.