TEXT-S&P revises Guitar Center Holdings outlook to negative
Overview -- U.S. musical instrument retailer Guitar Center is facing a $134.7 million applicable high-yield discount obligation (AHYDO) payment in April 2013 and its Holdco notes are also becoming cash interest pay in 2013. -- We believe the company will have to borrow under its revolver to meet its financing and operating needs during 2013 and that cushion to its senior leverage covenant will likely narrow to about 10% -- We are re-assessing Guitar Center's liquidity profile to "less than adequate" and revising our ratings outlook to negative from stable. -- We are also affirming all existing ratings on the company, including our 'B-' corporate credit rating. Rating Action On May 8, 2012, Standard & Poor's Ratings Services revised its ratings outlook on Westlake Village, Calif.-based musical instrument retailer Guitar Center Holdings Inc. to negative from stable. At the same time we affirmed all existing rating on the company, including our 'B-' corporate credit rating. We rate subsidiary Guitar Center Inc.'s $375 million revolver due 2016 'B+' with a recovery rating of '1', indicating our expectation for high (90% to 100%) recovery in the event of a payment default. We rate the company's $650 million term loan due 2017 'B-' with a recovery rating of '3', indicating our expectation for meaningful (50% to 70%) recovery of principal in the event of a payment default. In addition, we rate both Guitar Center Inc.'s $375 million cash interest-paying senior unsecured notes due 2017 and Guitar Center Holdings' $401.758 million senior unsecured notes due 2018 'CCC'. Both notes have a recovery rating of '6', indicating our expectation for negligible (0% to 10%) recovery in the event of a payment default. Rationale Our ratings on Guitar Center reflect our assessment that the company's liquidity is "less than adequate" but sufficient to avoid a default within two years. The March 2011 amendment of the company's capital structure allowed it to accrue 50% of interest on the Holdco notes for the next four payment periods, the last being in October 2012. Subsequently, the company will have to pay cash interest on these notes with the first payment due in April 2013. In addition, Guitar Center must make a $134.7 million AHYDO payment in April 2013. This cash payment represents accrued payment-in-kind (PIK) interest of $189.7 million on the company's Holdco notes that has been added to the principal, minus the first payment that the company made in the amount of $55 million. As such, we believe the company will have to borrow under its asset-based loan (ABL) revolver to meet its financing and operating needs during 2013. In our view, this will result in cushion to its net senior leverage covenant narrowing to about 10%. We view Guitar Center's financial risk profile as "highly leveraged," reflecting its high debt levels resulting from 2007 LBO transaction and weak cash flow protection measures. Although debt leverage decreased to about 8.9x at Dec. 31, 2011 from about 9.5x a year earlier, we anticipate that leverage will remain elevated due to additional borrowings under the company's ABL revolver. Also, we anticipate that EBITDA coverage of interest will remain thin, at about 1.1x. We view Guitar Center's business risk profile as "fair," reflecting its operational weakness during the latest economic downturn, offset by recently modestly improving profitability and its leading position in the highly fragmented and competitive music products retail industry. Although recent operational difficulties for Direct response segments were due to the headquarter relocation and Web redesign, we anticipate that increasing e-commerce competition will continue to challenge this segment of the company's operations. As such, our specific assumptions for Guitar Center include: -- Sales growth in the mid-single-digit percent due to modest same-store sales and incremental revenues from newly opened stores offset by weaker performance at the Direct Response segment; -- Modest EBITDA margin improvement as incremental costs to support new store growth offset benefits from sales leverage; -- Increased capital expenditure to support the opening of 10 to 20 new stores; -- Exercise of the PIK feature on the Holdco notes during the October 2012 payment period; -- The company makes the $134.7 million AHYDO payment in April 2013; and -- The company will be free operating cash flow (FOCF) negative during 2012 and 2013. Liquidity Liquidity is less than adequate in our view. Our assessment incorporates the following factors: -- The likelihood that Guitar Center will not be able to absorb low-probability adversities; -- We expect the ratio of the company's sources of liquidity to its uses to be less than 1.2x during 2013; and -- We also expect that cushion to the company's net senior leverage covenant will narrow to about 10% during 2013 Liquidity sources at Dec. 31, 2011 consisted of $106 million of cash and about $289 million available under its $373 million ABL facility. During September 2011 and subsequent to the Dec. 31, 2011 fiscal year-end, Guitar Center obtained a commitment to extend till February 2016 about $70 million of its $120 million non-extended portion of the ABL revolver. The remaining $50 million matures at the original date in October 2013. The company's term loan matures in April 2017, the senior notes in October 2017, and the Holdco notes in April 2018. We anticipate the company to be FOCF negative during 2012 and 2013. Recovery analysis For the complete recovery analysis, see the recovery report on Guitar Center, to be published following the release of this report on RatingsDirect. Outlook Our rating outlook is negative and reflects our less-than-adequate liquidity assessment. We anticipate the company will have to borrow under its revolver to meet its financing and operating needs during 2013. We therefore believe that cushion to the company's senior secured leverage will narrow to about 10%. A downgrade could occur if lower-than-expected EBITDA growth leads us to believe that the company could breach its financial covenants. Although unlikely in the near term, a positive rating action would entail our reassessment of liquidity back to "adequate" and leverage decreasing toward 6x. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Ratings Criteria: Ratios And Adjustments, April 15, 2008 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From Guitar Center Holdings Inc. Corporate Credit Rating B-/Negative/-- B-/Stable/-- Ratings Affirmed; Recovery Ratings Unchanged Guitar Center Holdings Inc. Guitar Center Inc. Senior Unsecured CCC Recovery Rating 6 Guitar Center Inc. Senior Secured revolver B+ Recovery Rating 1 Senior Secured term loan B- Recovery Rating 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. 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