There have been rumors recently that RadioShack (NYSE:RSH) is looking to refinance its debt at lower rates. This rumor is at least partially responsible for fueling the short covering that drove the stock up 19.8% in August in the face of a general market selloff. But how likely is a refinancing and what options does RadioShack really have?
At first glance, RadioShack has ample liquidity. It had $464 million of cash (including $32 million of restricted cash) at June 30, 2013. Since then it has paid off its convertible notes for $215 million, leaving cash of $249 million. At June 30, 2013, it had $394 million available under its credit facility. Total liquidity of $643 million with no significant near-term debt maturities sounds reasonable. But looking into the back half of the year there are reasons to be concerned. Vince Martin wrote an excellent article outlining those reasons here. Here are the highlights:
- Cap ex for the back half of the year at $40-$60 million (the majority of which will be spent on IT infrastructure, which is a whole other story for another time);
- Interest expense to be $25-$30 million (interest savings on the convertible bond should be offset by higher floating rates on the bank debt);
- Possible negative operating cash flow in the second half of the year, which I think will primarily be driven by working capital changes as the working capital benefit in the first half of the year is just not sustainable (based on the 10-Q, +$234 million accounts receivable; +$82 million inventory; -$156 million accounts payable in the first half led to a $160 million net benefit, which at some point needs to reverse).
So the back half of the year, traditionally the strong period for retailers, could lead to significant cash strain, with cap ex and interest expense amounting to roughly $75 million, and possible additional cash uses for working capital and continued operating losses.
If you are Joe Magnacca and Holly Etlin, what are your options here?
Continue to Run Down Inventory
RadioShack has been very successful running down inventory to raise cash over the first half of the year. Inventory balances decreased $82 million over the first half of the year, and the net impact from the inventory run down, increased collections on accounts receivable, partially off-set by a decrease in accounts payable, was $160 million in the first half of the year. Decreasing inventory is also part of management's strategic plan to reduce SKUs and make the stores cleaner. A win-win financially and strategically.
This in my view has been a strong move by management, but there is only so much fat that can be trimmed. Inventory is currently at $826 million, which is relatively low by historical standards. At June 30, 2011, inventories were $727 million, so there is probably some opportunity there, and management intends to continue the run down. Accounts receivable of $219 million is the lowest in recent history, however, so there is no room to raise additional cash there. A substantial amount of the decrease in accounts receivable related to a one-time receipt of a $56 million income tax refund. Accounts payable is also low by historical standards, at $201 million, but it's unlikely that this can be increased much given the lower inventory balance and supplier concerns over credit quality. All factors considered, there just is not much room to further increase cash by running down inventory and maneuvering working capital.
New Unsecured Bond Financing
Now that the convertible bonds have been repaid, the company's only bond debt is the $325 million 6.75% notes due 2019. These bonds trade at a substantial discount to face value. The $100 million second lien term loan pays in excess of 11% interest and the existing unsecured notes yield even higher than that. Under the term loan agreements, any bond would have to mature after the $100 second lien term loan, which means that the bond would have to mature sometime in 2018 or after. A maturity after the maturity of the existing notes would not be marketable so the only possibility here is an unsecured bond maturing in 2018 that is subordinated to the $100 million second lien term loan that already pays 11% plus interest.
In short, it seems almost impossible that they will be able to market an unsecured bond under these conditions, and even if they did it would need to carry an interest rate probably close to 20% or offer some other sweetener like warrants. They would have to get very creative.
Refinance the Credit Facility or Term Loan
In order to borrow at rates lower than the nosebleed levels available in the unsecured bond market, the company has put in place several secured lines, including a $50 million term loan due 2016, a $25 million term loan due 2017 and has $394 million available under its credit facility. Security for all facilities is secured by the company's main assets, inventory, cash and accounts receivable. In addition, there is a $100 million second lien term loan secured by the same collateral and all other assets of the company. Rates range from LIBOR plus 2.25% to 2.75% on the revolving facility to LIBOR plus 4.5% on the smaller term loans to over 11% on the second lien term loan. See 10-K.
Unlike other struggling retailers like J.C. Penney (NYSE:JCP), which has secured large term loans by pledging its substantial real estate, and Sears (NASDAQ:SHLD), which has been able to raise cash by selling real estate to compensate for continued operating losses, RadioShack does not own any material real estate. This is a big disadvantage versus these other retailers and significantly limits its financing options. It's only assets are cash, inventory and accounts receivable, and those have already been pledged. Moreover, the value of these assets has continued to decrease due to operational losses since mid-2012 when the credit facility was entered into.
One option is to refinance all of the existing term and credit facilities with a larger, longer-date term loan. However, if the $287 million spent to repay the convertible bonds were added as secured bank debt, this would substantially increase the amount of the secured debt. In September 2012 the second lien term loan lenders were only willing to lend at over 11%, and it is unlikely that lower rates could be achieved in a refinancing now, particularly since the value of the collateral has decreased over the last nine months and the total secured debt would be higher if any portion of the $287 million used to repay the convertible bonds were refinanced as secured debt.
In short, it is difficult to imagine that any additional secured debt could be added without lenders substantially increasing the interest rate, which already maxes out at over 11% for the second lien.
The other option is to utilize the revolving facility. This is not a long-term solution, but rates on the facility are relatively low, and it would not require amending the facilities, which would result in substantial fees. If the business can turn the corner in the near future, then a refinancing could happen at lower rates. But again, using a revolving facility as long-term financing is not a long-term solution. And it will substantially increase supplier nervousness.
The stock has enjoyed substantial increases in part due to rumors of a refinancing at lower rates. That seems very unlikely. The fact is that management does not have many options here. It's likely they will simply start to draw on the revolving facility because the bond market is not available and there is no capacity to increase total secured debt. But this is the right thing to do for the business because a 20% bond is not tenable and a refinancing and increase of secured debt would lead to substantially higher interest expense. The revolver, together with some continued inventory run down and a possible reduction or even an elimination of cap ex, will buy some time to work through the turnaround. These are not great options but this is survival mode.
Disclosure: I am short RSH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.