Guitar Center: The Last Song?

Seeing my old stomping ground Guitar Center in the news a few months ago was a major blast from the past. I instantly remembered spending hours in the store on San Mateo Street down the road from Coronado Mall in Albuquerque. I remembered buying my used Epiphone Explorer with the upgraded pickups and poring over the walls crammed with guitars of every kind. I am admittedly sad to see the company struggling today.

Guitar Center provides a great case study of how a leveraged buyout (LBO) can go quite wrong. With $1.6 billion in junk bonds outstanding – much of it originating from the company’s takeover by Bain Capital in 2007 – the company is struggling under its tremendous debt load and amid poor sales performance. As the company has slipped into the red over the last year and its cash pile has shrunk, the prospect of making interest payments has dimmed. In other words, the company is very close to bankruptcy.

What went wrong at Guitar Center, then? At the time of the deal, Credit Suisse analyst Gary Balter said the transaction seemed “like the perfect LBO.” He cited the company’s “dominant retail position” while pointing out that earnings still lagged behind other “high service” retail business segments. This was a good opportunity for Bain Capital to leverage (no pun intended) the strong Guitar Center franchise to improve the company’s operational performance.

The problem with Guitar Center is that it has clung to an antiquated business model, with 373 storefronts (as of December 2013) across the country according to CFO Tim Martin. To make matters worse, guitars don’t sell as well as they used to. Think about that one – does Kanye use a guitar? What about Katy Perry? Now that music can be made with a computer, expensive physical instruments have certainly lost some appeal.

Mr. Martin seems to be under the impression that he is not accountable for the company’s financial troubles. Of the impending crisis he says, “you can take a look at the financing aspect of it, but at the end of the day, that’s the owners of the company’s problem.” He goes on to argue that the company’s cash flow-positive stores would prevent creditors from seeking to liquidate the company.

The negotiations with Ares Management (owner of most of the debt) to take over Guitar Center are no doubt indicative of the long-term promise this company has. However, if the current executive team hasn’t made proper strides to modernise the company, they may all be sacked very soon. It’s also very likely that the new owners will close underperforming stores, leading to significant job losses.

Moving along from Mr. Martin’s callous disregard for the company he serves….

It’s safe to say Bain Capital’s takeover of Guitar Center has failed. While the company might have appeared stable enough to handle $2.1 billion in debt in 2007, changes in the consumer market for music instruments have made survival of GC in its current state all but impossible. Now, it could be Ares’ turn to revitalise this retailer. If they take the right steps to bring this company into the 21st century, we may yet live to visit a Guitar Center well into the future.

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