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Friday, Mar 29, 2024

Those Going Broke Blues

Guitar Center Inc., the country’s largest music equipment seller, could soon be the next in a recent succession of private equity-backed retailers to file for bankruptcy. The Westlake Village-based company carries more than $1 billion in debt, according to S&P Global Ratings. If Guitar Center is unable to increase sales and profits, the credit agency expects it to enter into default sometime in 2020. A Chapter 11 filing would put the company in league with retailers such as Toys R Us, Gymboree, Payless and Sports Authority, all of which failed to pay off their highly leveraged loan obligations after struggling to compete in a rapidly changing retail environment. S&P Associate Director Samantha Stone said Guitar Center needs to generate high single-digit to low double-digit profits over the next three years to avoid bankruptcy. “Guitar Center has very large and unproductive stores,” she said. “To turn things around, they need to be more thoughtful about their product and store space now that customers aren’t shopping at (brick-and-mortar stores) as often as they were in the past.” Heavy debt The company’s debt stems from a $2.1 billion leveraged buyout by private equity firm Bain Capital in 2007, which took the then-profitable retailer private and saddled it with $1.6 billion in liabilities. After years of disappointing sales, Bain sold the company to Culver City-based alternative asset manager Ares Management in 2014, a deal that reduced its debt to about $1 billion in total. Like most brick-and-mortar chains, Guitar Center has seen increased competition from online retailers including Amazon.com Inc. and eBay Inc., which often offer better deals on new and used gear. More than 15 percent of all instrument sales and services now take place online, up from 5 percent in 2009, according to a report by market research firm IBISWorld. “Industry revenue is likely going to decline as consumers continue to use online services, such as purchasing sheet music and utilizing online musical courses, over industry services,” the report said. Guitar Center makes online sales through its website as well as its subsidiary Musiciansfriend.com. Discount retailers such as Walmart Inc. have also begun selling entry-level guitars for just a few hundred dollars, which has taken market share from specialty retailers such as Guitar Center. As a result, the company’s annual revenue has dropped to an estimated $1.5 billion, a 14 percent decrease since 2012, according to IBISWorld. Also, some point to changing musical tastes to synthesized sounds of pop and hip hop music as shrinking the demand for guitars. But Stone at S&P said that even with a lack of contemporary guitar heroes, the company’s main challenges are no different from other debt-burdened retailers. “Many of these companies expanded very quickly into brick-and-mortar stores, and now they’re stuck with these long-term leases and they can’t overcome those fixed expenses,” she said. Between 2000 and 2005, Guitar Center expanded from 75 to almost 200 stores in the U.S., according to an investor presentation in 2007. In 2009, it also introduced a short-lived chain called Guitar Center Studios, where customers could rent studio space. The prototype GC Studio was located in Woodland Hills. By 2012, Guitar Center had opened 355 stores across the country. As sales declined, the company was forced to allocate a larger portion of its dwindling revenue toward expensive lease payments instead of paying down debt. It has since closed almost 100 stores, with more than 260 locations currently in operation. Recovery strategies Despite its recent struggles, there is still reason to believe Guitar Center can climb out of the red. In April, the company extended its separate classes of debt maturities by two years to 2021 and 2022 through an exchange offer with creditors. In response, S&P upgraded its corporate credit rating from SD (selective default) to CCC+. “The fact that they were able to get this deal is a testament to a belief in the viability in the business,” said Stone. Guitar Center said it plans to focus on appealing to its core customer base by investing in facility remodels, music lesson offerings, instrument rental and repair services and even new store openings. “Now that our refinancing activities are behind us, we are focused on implementing our strategic growth initiatives,” said Chief Executive Ron Japinga in a statement. “We’ve begun to realize the benefits of this work in our sales and earnings growth over the past few quarters, which is allowing us to make increased investments in areas that differentiate us.” Stone said that investing in services like instrument repairs and lessons allows Guitar Center to utilize its large store spaces in a smarter fashion. Guitar Center locations are often 10,000 square feet or more. Lessons, repairs and instrument rentals yield a higher margin than instrument and accessory sales. If Guitar Center hopes to avoid the fate of legacy retailers that failed to stave off default, it will likely need to give customers additional reasons to visit its physical stores other than buying a guitar. “They’re targeting their core customers, who are music enthusiasts,” said Stone at S&P. “They’re not trying to target (sell) accessories that consumers can buy on Amazon.”

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