September 10, 2012 - 4:28pm EST by
2012 2013
Price: 2.71 EPS $0.00 $0.00
Shares Out. (in M): 98 P/E 0.0x 0.0x
Market Cap (in $M): 270 P/FCF 0.0x 0.0x
Net Debt (in $M): 161 EBIT 0 0
TEV ($): 431 TEV/EBIT 0.0x 0.0x

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  • Retail


This is a fairly straightforward trade that is predicated on the fact that we believe RSH has ample cash and debt capacity to take out the coming 8/13 maturity of its 2.5% converts ($375mm).  The converts (trading at ~95 to yield 7% to maturity) are the only debt in the cap structure other than a $450mm revolver and the 6.75% unsecured notes of 2019 (issued at par last May and now trading high-60s to yield 14%).
RSH is a troubled company fighting for relevance in the mobility space which is dominated by the carriers and Apple.  While top-line has been relatively stable, gross margins have been decimated as carriers have changed their upgrade policies, leading to fewer trade-ins, and mix has shifted to lower margin smartphones.  The company has also made a number of missteps, particularly the structuring of its arrangement with Target (in which it operates 1,500 kiosks) such that it is unprofitable as the high margin sales of accessories do not accrue to RSH.
While we are not constructive on the equity and certainly believe that the company may not be around in 5 years, we do believe the company will easily get through its August 2013 convert maturity.  Once this maturity is dealt with, we expect significant tightening in the 2 year CDS (not to mention the benefit from the roll-down, which is quite steep at 12.5 -> 5.5 today.  Why?
  • Quite simply, the company has ample liquidity with over $550mm in cash (pro-forma for the recently announced $50mm TL) and ~$400mm in revolver availability.  We think the company needs ~$200mm in liquidity to operate, giving them ~$700mm of additional liquidity.  The company could pay down the converts entirely in cash and still leave their revolver undrawn, with no incremental financing done, if it was so inclined.
  • The company recently raised $50mm in bank financing from its existing ABL lenders at L+450 (in a last-out TL).  There is a $25mm accordion feature that can be drawn, and we think bank lenders would lend even more (perhaps on more stringent terms or with higher rate, if neccessary).  The support of the ABL lenders here, and desire to generate incremental loans/fees, cannot be underestimated.
  • If you compare RSH to previous retail bankruptcies, which the bears love to do, you will realize that RSH differs (and has very little incentive to file) in that:
    • Stores are much smaller (3k-5k square feet) and leases are much shorter (4 year average term), meaning that onerous lease liabilities are unlikely to drive this company into bankrupcty - the company could get out of 25% of its leases per year simply by letting them roll off
    • The vendor situation is manageable, with peak payables in the ~$350mm range - while we view this as unlikely, RSH could even survive (just barely) vendors going to 100% COD - however, the three mobility carriers make up 50%+ of the payables and are unlikely to want to push RSH into bankruptcy to protect relatively small amounts of money (they value RSH's 4k+ doors of distribution, especially in rural areas)
  • The converts do not have an incentive to file the company
    • The converts are structurally subordinated to the 2019 bonds based on guarantees and a large intercompany payable.  They would be at the bottom of the waterfall in a liquidation/filing scenario and will be heavily incentivized to avoid this
    • The company is talking to existing convert holders about potentially extending some of their position, giving them some combination of higher coupon, lower conversion price, and security
  • The company has over $1bn in current assets (inventory + high quality receivables) to secure debt against, vs $450mm of undrawn revolver and $50mm of TL
    • While we don't expect a 100% LTV, there is room for the company to do some 2nd/3rd lien financing after the existing bank debt
    • The company is looking to raise another $125mm-$150mm of debt, and that should be doable as a 2nd lien, especially in these hot credit markets
    • The company also has some amount of value (maybe $50mm) in unencumbered distribution centers and foreign subsidiaries

We expect RSH to raise an incremental $125-$150mm of financing by the end of the year, and perhaps to tender for a considerable portion of the converts.  This company is very challenged from an income statement perspective but we think the fears on the balance sheet are overblown, and the company does not have the need or incentive to file in the next 2 years.

Finally, there are several reasons to believe that the declines in EBITDA (from ~$400mm to $100mm today) will at least stabilize (after Q312 which will be ugly):

  • Q312 will be the last quarter of cycling the upgrade changes at Sprint, which have been extremely negative for the company - the company does not expect other major changes from the other carriers
  • Q412 will see the intro of the iPhone 5, which should drive sales, especially of accessories given the change in the required connector/dock
  • The company expects the Target relationship to be profitable by year end (probably losing ~$20mm of EBITDA today)


Incremental financing raised / tender for converts
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