Guitar Center’s real problem: their customers are broke

 

long-term-unemployedStephen Nellis at the Pacific Coast Business Times wrote a nice article about why Guitar Center’s future hangs in the balance of this last Christmas’ results and the debt-for-equity play by its major creditor. It is a nice summary of what has gone on so far, with a couple of opposing perspectives from Paul Majeski, the publisher of Music Trades magazine, and myself.

Majeski thinks everything is going great, except for that little thing when they wrote down a quarter-billion of the company’s goodwill in September of last year, not to mention the practices that led the ratings agencies to make Guitar Center a junk bond.

“If you look at the EBITDA, with the exception of third quarter where it tanked, they look very similar to Dick’s Sporting Goods. It’s a good model.”  

In my book of business analysis, taking $360 million off of goodwill because you are not likely to pay your debts off is quite an exception. Ahem.

Fun fact: The SEC is also interested in how Guitar Center’s EBITDA manages to look so good despite the exposure to very high-risk financial instruments called Payment In Kind (PIK) notes, which are generally higher-risk, higher-reward financial instruments that take the place of bonds or bank debt. The SEC’s questions are around why the interest from Bain Capital’s enormous debt do not appear in operating expenses, which would make EBITDA look less attractive.

Guitar Center Holdings does respond, saying that…if I understand this correctly… the interest payments on the money Guitar Center owes isn’t really an expense because it’s owned by the holding company, which isn’t Guitar Center – it’s Guitar Center Holdings – therefore it isn’t really an expense to Guitar Center:

With respect to Guitar Center’s consolidated statements of cash flows, interest on Holdings’ senior PIK notes is neither a liability nor an expense to Guitar Center. Therefore, the interest expense on the senior PIK notes is not an operating cash outflow in Guitar Center’s separate financial statements.

As a subsidiary of Holdings, Guitar Center is not the issuer of Holdings’ senior PIK notes.  In addition, neither Guitar Center nor any of its subsidiaries guarantees the senior PIK notes, and such notes are not secured by any of the assets of Guitar Center or its subsidiaries.

Payments made by Guitar Center to Holdings for use by Holdings in operations represent disbursements/repayments to a parent company. We present these disbursements in Guitar Center’s consolidated statements of cash flows as financing activities under the heading “Repayments to Guitar Center Holdings, Inc.”

In Guitar Center’s separate financial statements, we presented the exchange of cash interest for additional senior notes as a cash inflow and outflow from financing activities because it more clearly reflects a decrease in liabilities payable to the parent company and an increase in long-term debt payable to unaffiliated third parties.

So even though the gross margin earned from the sale of picks and strings and guitar cables goes to pay these debts off, it’s not really an expense. In fact, when they use money they make from selling microphones and drum machines to pay off old debts, this isn’t an expense – it’s actually a reduction in their liabilities, so is double plus extra good non-ungood money.

Oh, OK. This is an elite-level shellgame technicality, but that’s up to the SEC to work out.

The real problem – nobody got no money

My quote in the piece is regarding the fundamental problem – this is a business aimed a shrinking middle class:

“The customers are broke,” Garland said, “There’s nobody left to buy these products. We talk about inequality like it’s a philosophical thing. It’s a practical thing.”

The response from Mr. Majeski I think actually made me spit some coffee out.

“But Majeski of Music Trades said that the role of consumer spending is ‘overblown’ in the musical instrument industry. He said the bigger problem for Guitar Center is the online competitors…”

Dude, WHAT? This is an industry that depends on consumers – period. There’s no heavy industrial level drumset market. And professional musicians? We ain’t making any more of those compared to past decades that featured a record industry. So in what universe does lower consumer spending not matter?

This is a common self-deception in America in 2014: That we had some recovery and everything is normal.

We did not.

I commend to you one more time Monica Nixon’s perennial essay “THE CUSTOMERS ARE BROKE: That’s why there’s no recovery.

While not a day goes by that the American populace isn’t told by the Obama Administration and various bought and paid for corporate and banking shills that we are in an economic recovery, quantitative analytics on unemployment paint a starkly different and disturbing picture. Let us not forget, there cannot be a meaningful recovery in the US when 70% of the economy consists of consumer spending unless those consumers have jobs!

With that in mind, let’s have a look into that recovery…

THERE ARE 4 M FEWER PEOPLE EMPLOYED IN 2012 THAN IN 2007, WHILE THE LABOR FORCE INCREASED BY 12M!

A quick look at the BLS Labor Force Statistics database clearly shows that there were more people employed in the US back in 2007 that there were in 2012!
See here: http://www.bls.gov/cps/cpsaat01.htm

That’s right, 146M were employed in 2006 versus 142M in 2012! Keeping in mind the civilian non-institutional population shot up to 243M from 231M. Putting that in perspective, that’s 12 M more folks who need jobs but 4M less people employed! This should certainly lead one to question why exactly the unemployment rate hasn’t gone absolutely parabolic.

Or check out my piece, Your Future Sales Revenue Will Be Going to Student Loan Payments from 2011. Or my essay in Harvard Business Review, What Happens When There’s Is No Growth to Manage?

The statistics available are very clear, and so logical you cannot miss the implications: People without money do not spend it on stuff. Not stuff they need, and certainly not distortion pedals and new amplifiers.

All the private equity guys in the world can build an elaborate financial structure that lists interest expense as profit for every company on Earth for all I care. One way or the other, we must reckon with the harsh reality of having sold out the Middle Class.

  • Solitaire Miles

    Thanks for speaking out. I hear so many musicians crying about how they can’t get by right now, nobody wants to pay and gig attendance is low… at least here in Chicago. Well, that all happened here in IL when the state raised taxes and gouged hundreds out of paychecks per month. Doh… how stupid do you have to be to realize that the bad economy is hurting the music business, like so many other business that are going under right now? Get a day job man…. everyone has to survive and you might not be able to count on music to pay your rent.

    • http://www.ericgarland.co/ Eric Garland

      First, *hey everybody reading this,* go check out http://www.solitairemiles.com – this lady sings beautifully, just lovely music.

      When are you coming to St Louis for a gig? You’ve already got one bass player here you can count on.

      Second, we’re discussing this market dynamic for musicians at Transition Economics 2014, here in STL this May. One of the most popular pieces is by Dr. Jon Lorentz, a jazz educator and sax player, who declares the whole business dead-on-arrival – but that when we free ourselves from that past, we might be able to have a real music economy again. http://www.transitioneconomics.net/dr-jonathan-lorentz-decide-now-want-arts-next-economy/

  • Sam B.

    Certainly a valid point of view, BUT… the world has changed in more ways than a less monied middle and lower middle class. When I was young, if you wanted to sell your amp, guitar or instrument, it was to friends or via newspapers, or trade papers. Very awkward. Look on ebay today… 1000s of instruments, amps and accessories (new and used), many, if not most, being sold at low margins – putting price pressure on big box stores like GC. Also try getting real information about a product at GC. You can do better surfing the web for a while, visiting any number of blogs or small companies the specialize in a smaller range of products. I used to go to hang out at my local music store, to LEARN, to try instruments and to be part of the scene. GC’s are LOUD, crowded (with many people that will find what they want and surf the web to find it for a few $ less). GC has a rep for beating their suppliers for deepest prices – and yes they do sell allot of goods, but GC is LOSING money and paying BAIN for advise – which doesn’t seem like its $ spent on good value, at least so for for GC.

  • Done WithYou

    Haven’t you milked your 15 minutes of fame out of Guitar Center already? Your articles have grown quite cumbersome to read… Apparently, you weren’t aware that Guitar Center makes most people famous… Let it go! http://www.theonion.com/articles/new-study-finds-only-88-of-guitar-center-customers,35227/

    • http://www.ericgarland.co/ Eric Garland

      IP Address Geolocation: 207.108.162.42
      Server Connection: Guitar Center, Inc
      Location: Draper, UT, USA
      Salt Lake City Guitar Center
      >>>>>>>>>>>>>>>>>>>

      Greetings, Guitar Center employee from Utah: I don’t even have any more clever retorts for you comment trolls. I would tell you to focus on customers instead of screwing around on blogs, but given the debt structure that hangs around your neck like an oxen yoke, there’s really nothing you can do, except wait for the inevitable. Or, you could learn to communicate in the public sphere like a proud, free citizen instead of like a seventh grade gang.

      Grow up.

      • Stuart McDowall

        Feeeeeel the burnnnnn.

  • seriousfun

    Were you born five years ago, Eric? Consumers have no money…Because Obama? Seriously?

    • http://www.ericgarland.co/ Eric Garland

      Was this? A rhetorical question? Based on the article? Because Obama? Isn’t mentioned? And you can read? Up on consumer trends? Including debt? Spending patterns and CPI? On your own time? Seriously.

      • Jason Murrill

        Yeah, I’m thinking seriousfun read the quote from Monica Nixon’s essay, “not a day goes by
        that the American populace isn’t told by the Obama Administration and various
        bought and paid for corporate and banking shills that we are in an economic
        recovery,” and put 1 and 1 together and came up with 3.

        Monica didn’t say it’s Obama’s fault, but she is stating a fact that the
        administration, and a whole lot of others are saying we are in a recovery, when
        an honest analysis says, no we are not. The problem, if you actually read Eric’s
        piece, is much larger than “Obama,” but read into what you want.

  • Mary Stone

    What happens to a consumer economy when there are no longer any consumers…we shall shortly find out, thanks to all our wonderful pols who are busy protecting “job creators” from the consequences of their monumental selfishness and stupidity. Or view it another way, if you will: “if you make peaceful revolution impossible, you will make violent revolution inevitable.” I’m loosely quoting John F. Kennedy, noted socialist.

  • 1voice111

    I don’t agree.
    I think that the decline in instrument purchases is due to the playstation instant gratification generation.
    Entry-level, playable instruments are much more affordable than in the past, mostly due to Chinese mass-production.
    I remember spending $2200 for a digital piano in the early “90′s (It was easier to carry than my Fender Rhodes) , today I can get a gig-able digital piano for less than $500 that sounds better due to the fact that computer memory is exponentially cheaper . Recording gear is much cheaper , in the ’80′s an 8-track recorder and mixing board would set you back $6000 plus, today one can get into a digital production / editing suite with god-knows-how many tracks for a couple grand at most. Same goes for mics, efx, guitars, etc ….. most made in China.
    So for the mere price of a playstation and couple games , Junior could get a sweet setup (pick your instrument) , however Junior will have to put in time and effort to master said instrument. Much easier to fire up the playstation and zone out.

  • Pingback: How to get beyond the parasite economy

  • Jason Murrill

    “Dude,
    WHAT? This is an industry that depends on consumers – period. There’s no heavy industrial
    level drumset market,” has to be some of the best lines in a financial analysis piece, I’ve read. I’m glad
    I found this blog. I found it when a Facebook friend, Shane Benedict (one of
    the original gurus of Liquid Logic Kayaks) posted your piece, How to get beyond the parasite economy.

    I like the idea of a transition economy, where
    people get back to local/regionally owned sustainable business. I haven’t
    picked up my bass in awhile, but I have to say, it’s hard not to go buy Ernie
    Ball strings at GC for $20, versus going to my local music store, and paying
    $30-40, but my last instrument, and strings were all from a local store. I made
    a decision to support that local store, but the problem is the vast majority of
    consumers don’t really care, as long as they get their stuff cheap, they don’t
    care about growing the local economy, they don’t think about how spending their
    dollar locally, cyclically supports jobs and the local economy.

    I think a contributor to GC
    financial woes, is also what others have pointed out, we live in a society
    where it’s much easier for today’s children to turn on the Xbox or PS3, versus
    pick up and learn an instrument, or take part in some outdoor activity or
    sport, and parents let them do it, they let the computer, tv, or gaming console
    act as an ad hoc babysitter, and substitute their role as a parent to something
    that will distract their kids. I think it’s an underlying issue, that would affect
    GC, but companies like Shane’s as well. It’s about growing the sport, or hobby
    if you will. So I think being an advocate for transition economics is good,
    that’s the only way to make a difference really, is engage people, and get them
    to make conscious buying decisions. At the same time I think people have to advocate,
    and this is picking up steam somewhat, for children to drop the controller and
    pick up an instrument, or get outdoors and do something, or go paddle a kayak.

    • Jason Murrill

      Oh, and by the way, I am newly(as of last week) one of those 4 million people that were employed in 2006, but am now a member of the walking wounded of the, “economic recovery.” I could relocate, and make the same wage…Good thing for me I guess, is I will be finishing up that business degree this May.

  • Christopher Buttner

    Brilliant articles on Guitar Center. As someone who’s been in the Musical Instrument industry since 1992, one can only be baffled by the fact that Guitar Center has actually lasted as long as it has, when, in fact, it’s just following a much slower demise of one of it’s more massive competitors from the mid-1990′s, MARS Music: http://en.wikipedia.org/wiki/Mars_Music – Hopefully, the eventual demise of Guitar Center will revitalize the Musical Instrument industry, but not after tens, if not hundreds of millions of dollars of discounted musical instruments hitting the street at close-out prices.