Ever since I did a little bit of research on Guitar Center (at the behest of their CEO on my Facebook page, weirdly) I’ve been told that every time corporate finance gets mixed into the musical instrument business, things get weird.
The third major player in MI that is backed by complex finance is Gibson Brands, which owns Gibson Guitar Corporation, Philips, Onkyo, TEAC, and a few other companies in the consumer electronics space. The company is privately held, but they do have bonds available on secondary markets. If this sounds familiar, it’s the same deal as with how Guitar Center and other private equity firms borrow money for expansion: high-yield bonds subject to Rule144a, which works well for companies trying to keep from disclosing too much about their operations. Once you have bonds available to public markets, the ratings agencies (Moody’s, S&P, and Fitch) get involved.
Well, an executive recently hipped me to the latest news about what Moody’s thinks of Gibson’s creditworthiness as a corporation.
Um, whoa. Yikes.
And just like I did with Ukelele Barn, I’m going to need to dig into this so my musician brethren and sistren can understand the Orthodox Financier Pig Latin. Quit the beers and switch to coffee. This is gonna get complex, but it’s kind of a big deal.
Before I get started, I would like to disclose I have no commercial interest in the musical instrument industry, which remains primarily a drain on family finances and a topic of fascinating research. Also, I am a Strat and Tele guy. While I love Les Pauls and SGs in the right hands (Jimmy Page, Angus Young, Tony Iommi, Derek Trucks) I have never been able to dig them as a player myself. Great instruments, though. I mean, Wes Montgomery. B.B. King. Chuck Berry. Not much left to add.
Also, I would totally buy a Gibson ES-175 and try to sound like a pathetic version of Pat Metheny, but I spend a buttload on basses already.
What do I mean buttload? I mean I’m now into Foderas.
OK, while I’d rather discuss instruments all day, like every day since 1986, I guess we should do some finance.
Moody’s thinks Gibson is sorta screwed, and here’s why
I’m going to go through the most relevant parts of this press release and translate them into what I call Drunken Bass Player Dialect. As I often contend, finance usually involves very simple concepts tarted up with very fancy names. If you break things down into English, they are a little easier to understand, and usually sound a bit worse.
Moody’s Investors Service, (“Moody’s”) downgraded Gibson Brands, Inc.’s (“Gibson”) Corporate Family Rating (CFR) to Caa2 from Caa1 due to increasing concerns about the company’s liquidity position. The rating outlook is negative.
Moody’s is giving a shout out to anyone who owns Gibson Brands’ corporate debt and letting them know that they consider the creditworthiness of the company as a whole (not just a specific bond) has gone from junk to a little junkier junk due to the fact that they’re outta cash and owe a lot of money to other people. Oh, and things look like they’ll get worse.
The downgrade reflects Moody’s concerns about the company’s ability to meet all of its financial obligations in 2016 and 2017 that include over $80 million due to a consumer electronics supplier and $45 million in near-term outstanding indebtedness, if the ABL revolving credit facility is not refinanced
Moody’s is now calling Gibson debt junkier junk because they have agreed to pay people a bunch in the next 14 months, and it ain’t looking so hot. They owe one of their vendors $80 million – a helluva steep individual invoice to pay – and another $45 million in the short-term unless they can find some other bank to make them a new deal on their asset-based loan, which is like a company credit card secured by Les Pauls and SGs in the warehouse.
The expiration date of the ABL was recently accelerated to May 2017 from January 2018 because the company was in violation of a covenant. “However, we expect that the company will be able to refinance the ABL based on the strength of the underlying assets,” said Kevin Cassidy, Senior Credit Officer at Moody’s Investors Service.
Gibson had until January 2018 to sort out this asset-based loan thing, but that got moved up to May 2017 because they broke one of the agreements they made when they borrowed that money. That said, they have a lot of Les Pauls and woodworking tools and other assets, so somebody will probably make them a new deal.
“We expect Gibson’s operating performance to improve this year, but remain below our original expectations.” noted Cassidy “We think the chances of some type of debt restructuring will increase as the company approaches the August 2018 maturity of its $375 million notes.”
The guy from Moody’s said that while Gibson might sell a little better in 2016 over 2015 (Ed. note: as all those automatic tuner guitars still churned through the guts of guitar shops, causing indigestion.) things are still not awesome. Also, they owe their investors $375 million in cash by August 2018, as they have to return the principal of those bonds they issued.
Side note on bonds for newbies
In corporate bonds you let the public – mostly investment funds from big banks – give you a wad of money and you collect the annual interest or “coupon” every six months or so. If it’s $100 and the coupon is 9% and you issue the bond January 1, then you pay investor $4.50 on July 1 and $4.50 on January 1 until the bond matures. This is why these investments are “fixed income” as opposed to stocks where you might get a dividend, or you try to make money when you sell the stock for a higher price later.
Meanwhile, back at Gibson, which owes a lot of money
Where were we? Oh yeah.
Corporate Family Rating to Caa2 from Caa1;
Probability of Default Rating to Caa2-PD from Caa1-PD;
$375 million senior secured 2nd lien notes due 2018, to Caa3 (LGD 4) from Caa2 (LGD 4)
All that is to say that Moody’s sees them as one step deeper into junky you-might-not-get-all-your-investment-back territory. But CFR means “the company’s debt as a whole,” probability of default means “chances you walk away with less than you’re owed or zilch,” and the $375 million of senior secured notes means the specific bonds they have outstanding right now. Key takeaway: Banjo Shack is looking better by comparison.
Actually, we should probably take a look at those high-yield bonds that Gibson has outstanding.
You can check this out yourself in the FINRA database. The basics here are:
- Gibson Brands has taken $375 million from investors.
- The coupon to investors is 8.875%, already high-yield (junk) territory that assumes a risk default.
- They offered the debt around August 1, 2013, and it matures after five years of paying the coupon, meaning they owe their investors back the principal.
- Both Moody’s and Standard & Poors have downgraded the ratings on this debt very recently.
- The secondary bond market has been FREAKING OUT, dumping these bonds on speculators for cheap. That spike of yield this summer means that original investors were selling their bonds to secondary investors for half of what they paid. If they gave Gibson $100, they sold those bonds to another guy for $50, meaning they were afraid to lose even more of it if they waited until August 1, 2018.
- This means that investors roughly estimate that there’s a one-in-four chance that either Gibson won’t make all its coupon payments or return all the money it owes, a.k.a. default.
Moody’s mood, or its rationale for downgrading Gibson
Moody’s press release goes into further detail for why it is bearish on investing in Gibson Brands.
Gibson’s Caa2 Corporate Family Rating reflects the company’s untenable capital structure based on expected operating performance, weak liquidity profile, soft credit metrics and the highly discretionary nature of its musical instrument and consumer electronics product lines.
“Damn son, this is a hot mess.”
The ratings also reflect the company’s high leverage at over 10 times debt/EBITDA at March 31, 2016 and concerns that there continues to be high turnover in the company’s senior financial management level.
This means that the company owes a whole lot of money compared to what it makes in earnings with that leverage. Also, it’s executive musical chairs, which means borrowers don’t know who’ll be running the company in the near-term future.
Gibson’s ratings are supported by the company’s strong brand recognition in musical instruments and market share for guitar products, and diversified product line within guitars and related music areas. The ratings are also supported by its geographic diversification.
Moody’s is saying that all is not lost; Gibson is still one of the top killer brands in all of MI, and having a wide range of music and audio products is on balance something with intrinsic value. There’s value there. Also, that value is worldwide, not just US-focused.
The ratings could be lowered if the company does not successfully address its upcoming debt maturities that include:
a) $32 million of financial obligations to a consumer electronics supplier by December 2016, of which $25 million currently remain outstanding;
b) Refinancing of a $75 million ABL facility (of which $45 million is currently outstanding) maturing in May 2017;
c) Over $50 million of additional financial obligations to a consumer electronics supplier by December 2017
“Remember that stuff we said we’re worried about? Yeah, if it doesn’t get better, ooh, that would be even yuckier. But we’ll cross that bridge when we come to it.”
While unlikely in the near term given the negative outlook, over the longer term an upgrade could be considered if Gibson successfully addresses its upcoming debt maturities and improves and sustains its operating performance.
This last statement is consistent with the overall negative outlook from Moody’s. “Could we upgrade these guys? Sure. Like, if they stop defaulting on their debt covenants and get people paid off and pull off some sweet moves and make some money, that would be awesome. And also, there is a certain chance of monkeys flying out of our butts. So we’ll believe it when we see it.”
Some final thoughts on the future of the guitar business
Corporate finance is a jolly way to effectuate rapid expansion and make strategic-looking plays for assorted companies. It is also a great way to get in a lot of complex debt very quickly.
If there’s anything I’ve concluded in looking at that musical instrument industry in greater depth since covering Mandolin Hut, it’s that this business is kind of resistant to complexity. Guitars. Picks. Amps. Cabinets. Cables. Speakers. These are artisanal products that are rather simple. They provide joy. They’re made of wood and metal. Adding tons of sophistication, from either software algorithms to business models, seems a risky play. We musicians are a simple lot. The joy of a Les Paul blasting an A-chord through a Marshall and thus through your pants is not complicated, but it is addictive. Get too far away from those equations, and trouble seems to brew.
Otherwise, I think that the fundamental issue for guitar manufacturers is cultural, not technocratic. Rather than focus on a cross-technological, spectrum-spanning, electromechanical, consumer-creator-hybrid growth hacking play, we gotta get more people to play guitar and keep playing guitar. We gotta get people from Epiphone to Gibson, from D chord to D dorian mode, if you dig. Figure out how to inspire the love of actual tube amps in a tone-simulated digital world. We must take action like the Irish monks who saved antiquity from the witch-burning idiots who didn’t know a good thing when they saw it.
This might coincide with complex Wall Street finance, but from my point of view, that trend doesn’t seem compelling.
However, we might need to put Slash in charge of the Kennedy Center.
What do you think? Let’s hear it in the comments.