A Levered Retailer, 2005–2018Medium

What happened

• 2005 — a large toy retailer is taken private by a consortium in a leveraged buyout, financed with a substantial debt package.
• 2005–2017 — the company services its debt. Operating performance is not the immediate problem; the interest is paid.
• Over the same period — online competition grows and store investment falls behind, because cash that would have funded it is servicing the structure.
• September 2017 — with a large maturity approaching and refinancing not available on workable terms, the company files for Chapter 11 intending to reorganise.
• March 2018 — the US business moves to liquidation instead.

The mechanism

• Leverage is a maturity risk before it is an interest risk. The calculator on the leveraged finance desk shows a structure that services its debt comfortably and still ends the horizon with most of the principal outstanding.
• Refinancing is a market, not a plan. A borrower that intends to refinance is exposed to whether the market is open on a date it does not control.
• Capital expenditure is the discretionary line. In a levered structure it is what gets cut, and the cut compounds against a competitor who is investing.
• Chapter 11 does not decide the outcome. It is a process, and it produces a reorganisation only if there is a plan somebody will fund — see DIP financing.
• A supplier and a landlord are creditors too. A retailer's counterparties tighten terms as soon as the process starts, which removes working capital exactly when it is needed.

What it teaches

• Model the maturity, not only the coverage. An interest cover ratio can be comfortable in every year and say nothing about the year the principal is due.
• Ask what the leverage is preventing. The cost of a levered structure in a competitive industry is frequently the investment that was not made.
• A filing is not the end of the analysis. Whether the fulcrum sees value in a going concern decides between a reorganisation and a wind-down.
• The failure took twelve years and looked fine for eleven of them. That is the ordinary shape, and it is the reason a snapshot of coverage is not a credit view.

The mechanisms behind this

Every case on this site is an instrument or a mechanism doing exactly what it was built to do, in a situation nobody had pictured. These are the pages that explain the machinery:

• Leveraged buyout — the structure and where its return comes from.
• Chapter 11 — what the process can and cannot do.
• Wind-down — the outcome when no plan is funded.
• Amend and extend — the maturity fix that was not available here.