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RadioShack Is Poised To Fail

|Includes: RadioShack Corporation (RSH)

The run over the past days broke the downward trajectory of a company that should better file for Chapter 11. These unusual fluctuations were triggered by alleged discussions between RSH's management and Standard General, the hedge fund holding about 10% in RSH since the beginning of the year. Actually they don't simply own those shares but piled up over the second quarter as RSH lost value and added 3 million call options as well. Litespeed, another hedge fund is also holding 10% of the stocks since late 2013/early 2014. Both of the funds manage about $1-1,5 billion, thus a 1% bet for each does not look to be a high conviction bet. Both of the hedge funds invest through Chapter 11 restructurings and are rather debt shops, thus I suspect they are also holding bonds. Based on their experience to go with firms through restructuring and their minor share in their portfolios I doubt they would vigorously fight to help RSH avoiding bankruptcy. Standard General does not have a stellar track record and uniting American Apparel's and RadioShack's troubles is just…weird.

Standard General and Litespeed might initiated their position based on premises that Joe Magnacca would accomplish a turnaround this year since RSH renewed financing at the end of 2013. But since Magnacca took over as CEO, he could not stop or even decelerate the business deterioration. He is around since February 2013 and - like his predecessors over the last 4 years - could not even maintain revenues. This won't even happen this year, what was indirectly acknowledged by the fact that he is pushing to close stores as long as they get back to profitability. Needless to reiterate that creditors vetoed a major cutback that would affect up to 1100 stores out of about 5500 that they still have. Magnacca would reinvigorate the brand by better focusing on local communities (is there any retailer that should not?) with RSH being converted to a specialty electronics retailer selling internet-of-things and private label devices and targeting innovators like the Maker Movement and other niche groups like veterans. Even if this is the way to go the repositioning would take years. In the early 2000s they started to focus on mobile phones and it took years to build up a proper business line.

Debt holders have to block this plan: the targeted customer base is much smaller and even if the strategy would work out over time, a tiny retail chain would be the outcome. Whether a strategy targeting innovative geeks could ever make them shop at a company that is deriving 1% of its sales over the internet is easy to answer. And as a retailer, they should know how to sell things...did you see any of their recent commercials? Anyways, doing this transformation would be a bad option for creditors, because if RSH fails in-between, they will have a much smaller firm to liquidate. Don't forget that RSH has already more leverage than peers. Therefore, before RSH met Standard General creditors met Houlihan Lokey, the Nr. 1 restructuring advisor worldwide. This shows they are determined to end the party: they allegedly tried to push through a restructuring plan late last year (Magnacca didn't take it), then turned down him this spring so it is hard to believe that Standard General will turn the tide in the end.

Conflicting interests postpone a would-be deal when RSH is burning more than $100 million in cash a quarter since early 2013. When projecting decline over the past quarters they should have run out of money these weeks. They still have a credit line of $300+ million that could keep them alive for some 3 quarters. But there are news coming out for months about an expected bankruptcy and it won't be easy to persuade jittery suppliers to ship inventory before the shopping high season. Don't forget: Circuit City was not able to maintain supply of products before they went bankrupt and they would go into an immediate liquidation back in 2009. In my opinion it is unlikely that Standard General will write a cheque about several hundred millions, because they are simply too small. If they don't, they can't buy enough time for RSH to try some new tricks.

If nobody would come and rescue from outside, they could still survive based on their merits. Unfortunately, their operations are totally dismal. Issues in competitiveness did not start recently, actually RSH consistently lost ground over the last 20 years. Revenues have been in 93 $4,1B-$5,3B-$4,77B-$4,84-$4,25bn in '93, '97, '01, '04, '07, respectively. They maintained this level through 2009 and subsequently gradually slipped to $3,4B in 2013. Keep in mind that Best Buy grew tenfold in nominal revenues and Amazon became a mammoth from nothing in this time period. Lack of competitiveness is crystal clear when looking at the handheld devices business: when RSH started to sell mobiles it made around 20% if its revenue or about $1B. Last year 50% or $1,7B of their revenue came from handheld devices. During the same 10 years the smartphone market grew eleven fold while RSH could not double same-store sales. As a matter of fact consumer electronics boomed through the last 20 years. This helped RSH to maintain stable operating profits and cash flows but the market is getting saturated and they won't get a free ride any more.

In the last three years they have lost over 10% in revenue year-to-year. Gross margins have been decreased from 48-50% to around 30%. Consumer electronics margins are the worst in the retail space spanning 5-8%. They would need to increase margins rapidly but why would you buy your second, third iPhone from RadioShack? Manufacturers are increasingly pushing less expensive products, which is slowing the rate of revenue growth at a time when no new "must-have" category of devices has emerged. They see all this and look to decrease footprint from between 6500-7500 stores nationwide between 1993-2010 to around 4000. I believe debt holders don't believe they will be able to transform business since they earlier tried to cut costs (Fix 1500 initiative, layoffs), introduced new store concepts (PointMobl) and tried to expand business abroad (Canada, Australia and Europe all failed) and they just consistently - failed.

As a consequence creditors are working on a restructuring plan and RSH is trying to win some months. When Circuit City collapsed in November 2008 they were in a horrible shape and fell into the hands of liquidators. If RSH would be alive beyond December 2014 they would have at least a chance to be restructured.

Disclosure: The author is short RSH.