RadioShack (RSH) has calmed investors, at least for the time being, with news that it has secured committed financing from GE Capital, consisting of a $585 million credit facility and $250 million term loan, which will be used to refinance $175 million of existing term loans and cancel the existing $450 million revolving facility. In total, the company expects the new financing to add $175 million in incremental liquidity.
I do not believe that the new $835 million of financing buys the company much time, particularly considering its current rate of cash burn excluding working capital changes. See here. But here's an even more basic question: is this new financing even permitted under the company's 2019 bond indenture?
The 2019 Indenture
First, a mini-primer on bond indentures. High yield bond indentures like the RadioShack 2019 indenture include various affirmative and negative covenants. The affirmative covenants are very limited - basically, the company agrees to pay interest, principal and change of control payments, and that's it. Bond indentures do not typically include affirmative "maintenance covenants," which require companies to maintain certain leverage, interest coverage or equity levels. The negative covenants are incurrence-based, which means that they can only be violated if the company actually does something. The most important negative covenants are the debt covenant and the restricted payments covenant, which regulate when the company can incur new debt and make new restricted payments, respectively. Typically covenants are initially set with wide headroom because it is so difficult to get waivers or amendments from bondholders.
In order to incur the $835 million of secured loans, RadioShack must be permitted to incur the $835 million in new loans under the debt covenant in the bond indenture. That covenant contains several "baskets" of permitted debt. The relevant basket is the credit facilities basket, which permits (see Indenture):
(1) the incurrence of Indebtedness under Credit Facilities by the Issuer or any of the Subsidiary Guarantors and the issuance and creation of letters of credit and bankers' acceptances thereunder (with letters of credit and bankers' acceptances being deemed to have a principal amount equal to the face amount thereof), up to an aggregate principal amount not to exceed the greater of (1) $450.0 million outstanding at any one time less the outstanding principal amount of any Qualified Securitization Financing and (2) the Borrowing Base Amount;
The "Borrowing Base Amount" means:
as to Issuer and its Restricted Subsidiaries, as of any date, the sum of (without duplication) (1) 80.0% of the face amount of wireless receivables of the Issuer and the Subsidiary Guarantors; (2) 82.5% of the book value of all inventory owned by the Issuer and the Subsidiary Guarantors; (3) 85.0% of trade receivables (other than wireless receivables and credit card receivables) of the Issuer and the Subsidiary Guarantors and (4) 90.0% of the credit card receivables of the Issuer and the Subsidiary Guarantors, in each case, calculated on a consolidated basis and in accordance with GAAP (and excluding, for the avoidance of doubt, any such assets that are subject of a Qualified Securitization Transaction). In the event that information with respect to any element of the Borrowing Base Amount is not available as of any date, then the most recently available information will be utilized.
Does RadioShack's "Borrowing Base Amount" equal $835 million?
The short answer to that question is: we don't know. Unfortunately, the quarterly accounts do not provide us with enough detail. For example, the accounts receivable line item includes several items that don't go into the "borrowing base" like any tax receivables, vendor receivables for residual income and promotion, wireless marketing development funds, other receivables, etc. These are broken out in the 10-K to some degree (see Note 3 -- Supplemental Balance Sheet Disclosures) but not the 10-Q.
The Existing Credit Agreement
Fortunately, the existing credit agreement provides some clues. RadioShack discloses in its 10-Q that its borrowing base under the Credit Agreement was $369.4 million as of September 30, 2013. See 10-Q. The "borrowing base" definition in the credit agreement is a little different from the definition in the bond indenture. Here's how it is defined in the credit agreement.
"Revolving Credit Borrowing Base" means, at any time of calculation, an amount equal to:
the face amount of Eligible Wireless Receivables of the Loan Parties multiplied by eighty percent (80%), provided that the aggregate amount of Eligible Wireless Receivables of the Loan Parties included in the Revolving Credit Borrowing Base and the Term Borrowing Base shall not, at any time, constitute more than twenty-five percent (25%) of the Maximum Aggregate Borrowing Amount;
the Cost of Eligible Inventory of the Loan Parties (other than Eligible In-Transit Inventory), net of Inventory Reserves, multiplied by eighty-two and one-half of one percent (82.5%) multiplied by the Appraised Value of Eligible Inventory of the Loan Parties;
(3) the Cost of Eligible In-Transit Inventory of the Loan Parties, net of Inventory Reserves, multiplied by eighty-two and one-half of one percent (82.5%) multiplied by the Appraised Value of Eligible Inventory of the Loan Parties;
(4) the face amount of Eligible Trade Receivables of the Loan Parties multiplied by eighty-five percent (85%);
(5) the face amount of Eligible Credit Card Receivables of the Loan Parties multiplied by ninety percent (90%);
(6) without duplication, the then amount of all Availability Reserves;
(7) the Availability Block
Parsing the definition shows that there are a few important differences between this definition and the definition in the 2019 bond indenture. First, there is a limit on eligible wireless receivables of 25%. Second, inventory is based on an appraised value percentage, which could affect the calculation if the appraised value were less than cost, and is explicitly net of inventory reserves. The "Eligible Trade Receivables" and "Eligible Credit Card Receivables" are also slightly different from the descriptions in the 2019 bond indenture and have certain exclusions such as an exclusion for past-due receivables, etc. The "Availability Block" is $45 million.
It is difficult to quantify the significance of the difference between the definitions. But we know that the borrowing base under the credit agreement was $369.4 million as of September 30, 2013. The question then is: how likely is it that the 2019 bond indenture borrowing base was $835 million - large enough to permit the new financing - when the credit agreement borrowing base is only $369.4 million? That's a $465.6 million delta.
I'm not suggesting that RadioShack is intending to violate its bond covenants. That is unlikely, particularly with GE Capital around to do their own diligence. But I do think it is likely that the bond borrowing base is not $835 million and if RadioShack intends to do a $835 million financing, it will have to increase its borrowing base calculation.
There are several ways to do this. With the holiday quarter upon us, there will be some natural increase in inventory levels, at least up until the heavy shopping weeks in early December. The company could also temporarily extend payment terms on its wireless receivables to build up that balance. I suspect, though, that the primary method will be increasing inventory balances.
This is also why I expect the financing to close in early December when inventory balances will naturally be the highest. If, however, the "right" level of inventory for the business does not create enough borrowing capacity, and the company believes it is critical to be able close on the $835 million of financing that it has signaled to the market, the company would have the incentive to purchase more inventory than they need just to increase their borrowing base calculation. That would be particularly dangerous for an electronics retailer where inventory becomes obsolete so quickly. Moreover, this limitation puts a lot of pressure on the company to close the financing in early December when inventories are naturally at the highest. Bringing the borrowing base calculation up to $835 million in January would be much more difficult.
We unfortunately do not have all of the numbers to determine whether this will be a significant issue but I do not think it is likely that the differences in the definitions account for much of the $465.6 million delta. If that's correct, the company would be incentivized to over-purchase inventory to be able to close on the new financing. I think there are other (more important) reasons to avoid the stock right now. But this is something to keep an eye on.