Earlier I have written that the pending RadioShack (RSH) refinancing buys the company time, but not much. That conclusion was based on the analysis that the refinancing nets the company an additional $40 million of funded debt while the normalized cash burn based on third quarter performance was $62.9 million. Now that I have had time to give the 10-Q a good read, there are some significant adjustments to make to that analysis. The conclusion is that the new financing buys the company only 41 days of additional life-support.
Refi Nets Only $40 Million New Funded Debt
RadioShack management has stated that they believe the refinancing will add approximately $175 million of net additional liquidity. The new $835 million of new financing consists of a $585 million credit facility and $250 million term loan, which will be used to refinance $175 million of existing loans and cancel the existing $450 million revolving facility. The difference between sources and uses is $210 million, indicating around $35 million of prepayment fees, commitment fees, transaction expenses and/or OID to get to the $175 million figure management used. Like I wrote earlier, this is an expensive refinancing.
This means that we can calculate the additional funded debt (ie excluding the revolver) as equal to $250 million new term loans, less $175 million repaid term loans, less $35 million transaction costs, which comes to $40 million. That is the bottom line here - the new refinancing nets a mere $40 million of new funded debt.
Why don't I include the undrawn $585 million revolver and instead focus on funded debt? The answer is because revolvers are not long-term financing. Revolvers typically mature earlier than the term loans and contain limitations on borrowing, including a borrowing base maximum or other conditions, and often contain clean-down provisions. Just look at JC Penney (JCP) or even RadioShack earlier this year when both were hit with significant liquidity fears. Each had large undrawn revolvers that did not calm investors or suppliers. Something had to give and you saw JC Penney issue dilutive equity offering and RadioShack arrange this expensive refinancing. What is the benefit of increasing the revolver from $450 million to $585 million in this context?
Updated Normalized Cash Burn
In a previous article I included an expected normalized cash burn rate based on the third quarter results. Having had time to dig through the 10-Q, I am now updating that chart for some significant one-time benefits that were buried in the 10-Q. These include (1) a reduction to SG&A of $5.3 million for a one-time settlement of a dispute with a non-merchandise vendor; (2) a reduction in SG&A of $2.4 million for a gain on a one-time sale of a building; (3) an income tax benefit of $14.3 million from a one-time settlement of an IRS examination of tax years 2004 through 2006; and (4) an income tax benefit of $3.5 million related to a change in the measurement of a tax position taken in a prior period. See 10-Q. The updated normalized cash burn chart is below.
Gross Profit ($242.7 plus $47 effect of one-time inventory disposition)
Less: One-time settlement of dispute with vendor
Less: One-time sale of building
Less: Capital Spending (substituted for D&A)*
Less: Net Interest Expense
Plus: Income Tax Benefit
Less: One-time settlement with IRS re 2004-2006
Less: One-time benefit for change in measurement
Normalized Cash Burn
* Capital spending for the first nine months of 2013 was approximately $26 million. Management estimates between $45 and $55 million of capital spending for the full year, leaving $24 million of expenditure in the fourth quarter based on the mid-point of the range. See 10-Q.
That nets out to a normalized burn rate of $88.4 million. Having gone through this now with a fine toothed comb I am comfortable that these additional adjustments for one-time benefits get a truer picture of the state of the business. For example, in the second quarter the income tax benefit was $1.8 million. We are unlikely to see $16.8 million again.
It's not uncommon for companies to throw all of their dirty laundry into a quarter that they already know is going to be bad. Here we have the opposite - all of the one-time items were benefits and made the terrible results look better than they actually were. Even backing out the gross margin reduction from the inventory RadioShack disposed of during the quarter (and you have to ask whether there is more to come), the underlying cash burn was $88.4 million.
Where Does That Leave Us? 41.3 Days
Unless RadioShack can improve its underlying business results substantially, the underlying cash burn rate based on the third quarter of $88.4 million will run through the $40 million in new funded debt in all of 41.3 days.
Results will likely show improvement during the fourth quarter driven only by holiday sales. But if the company cannot show improvement by the first quarter, it will quickly find itself in a worse cash position than it currently is in, and be saddled with additional $75 million of leverage from the $250 million second lien term loan. Combine that with the possibility of additional inventory purchases to comply with its debt covenant (see here) and you have a company that will have a very difficult time going another six months without attempting to sell substantial equity.