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RadioShack lenders seen escalating default risk

Matt Robinson
(c) 2014, Bloomberg News.
RadioShack's lenders are blocking its plan to close 1,100 unprofitable stores to save money, deepening speculation among derivatives traders the electronics retailer will default within a year.

The lenders, whose consent RadioShack needs to shutter more than 200 sites a year, weren't willing to provide permission on terms acceptable to the company, according to a May 8 regulatory filing. The denial, which prevents RadioShack from paring cash outflows, has caused demand for protection against non-payment to increase. Credit-default swaps now imply a 45 percent chance of default in December and 86 percent by June 2015, according to data compiled by Bloomberg.

"The company is running out of options for its turnaround strategy," Moody's Investors Service analyst Manoj Chadha said. Liquidity is going to deteriorate and RadioShack may start to lose vendor support, making it difficult for the company to continue as a viable operation, Chadha said.

Ruth Pachman, a spokeswoman for RadioShack at Kekst & Co., declined to comment on the reduced store closings or the default implications based on swaps trading.

RadioShack is seeking to boost efficiency and develop new products to overcome a sales decline of 45 percent since the 1996 peak as it struggles to compete with online companies such as Amazon Inc. and merchants including Wal-Mart Stores Inc.

While RadioShack said in a March 4 filing that it would have enough cash to meet obligations through year-end and has until December 2018 before any debt comes due, its vendors may decide its finances are too precarious to warrant advancing credit and push it into bankruptcy, said James Goldstein, an analyst at CreditSights Inc., who rates the Fort Worth, Texas- based company's bonds "underperform."

Without the consent of the senior lenders, RadioShack will now pursue "other cost reduction measures," according to the May 8 filing. The company is continuing discussions with lenders about the store closures, according to the filing.

"They're being forced by their lenders to lose more money," said Noel Hebert, an analyst with Bloomberg Industries. "They're in an incredibly difficult cash position."

The lenders extended $835 million in five-year financing in October, led by GE Capital and Harbinger Capital Partners LLC's Salus Capital unit.

Ned Reynolds, a GE Capital spokesman, declined to comment on the impasse, as did Brian Ruby, a spokesman for Salus at Integrated Corporate Relations Inc.

The price of RadioShack's default swaps expiring Dec. 20 soared to 28 percentage points upfront on May 9 from 23.8 percentage points before the company announced the scaled-back store closings, according to CMA, which is owned by McGraw Hill Financial Inc. and compiles prices quoted by dealers in the privately negotiated market.

That means the initial cost to protect $10 million of debt increased to $2.8 million from $2.4 million. Swaps maturing in June 2015 rose to 53 percentage points upfront.

The 13-month contracts, which ended at 49 percent upfront Tuesday, reached a record 54 percent on April 22, after the Wall Street Journal reported the company was running into difficulty getting lenders to approve the store closings. The December swaps were quoted at 24.6 percent Tuesday.

Trading in RadioShack credit swaps surged after the report that lenders were balking, with $830.2 million of protection bought and sold in the five days ended April 18, up from $346.5 million the previous week, according to the Depository Trust and Clearing Corp., which runs a central registry for the market.

The high premium paid for near-term default protection is attractive given the company doesn't have any debt maturities until 2018, said Paul Karpers, a money manager at T. Rowe Price Group Inc. who's starting a new credit opportunities fund that he said would probably use credit swaps to wager on companies like RadioShack.

While the company is "certainly troubled," he said, "the amount of distress that is priced into" the near-term contracts is too high relative to the amount of liquidity it has.

RadioShack's $324.8 million of 6.75 percent securities have dropped 22.4 cents on the dollar this year to 41.1 cents to yield 30.44 percent, according to trades of $500 million or more compiled by Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Chief Executive Officer Joe Magnacca, a former drugstore- chain executive, has hired a new team of managers, including Dollar General Corp. executive John Feray as chief financial officer in January, to help him institute a turnaround.

While RadioShack's shares have plunged 46.5 percent this year to $1.39, Standard General LP, a New York-based hedge fund, announced a 9.8 percent share holding in an April 29 regulatory filing. That's a sign some investors may be confident RadioShack can avert a default, said Oliver Wintermantel, an analyst at International Strategy & Investment Group in New York.

"They're probably buying because the stock can double or triple if they come out at the end of May and report a stabilization in earnings," he said by telephone. "It's a binary event at this point, either they file for bankruptcy or they don't. If they don't, the stock is probably going up."

Michelle Pereira, a spokeswoman for Standard General, declined to comment on the increased stake.

RadioShack's sales declined 20 percent in the fourth quarter, the most since 1999, Bloomberg data show. Analysts surveyed by Bloomberg forecast RadioShack will burn through $186.4 million of cash this year, more than its $179.8 million in reserves.

The deadlock between creditors and management is "credit- negative" for the retailer, Moody's said in a May 9 statement. Moody's lowered RadioShack's credit rating to Caa2 in March, saying the retailer's turnaround strategy "doesn't seem to be gaining much traction." The rating outlook is "negative."

Moody's Caa2 ranking, denoting debt that is "subject to very high credit risk," is eight levels below investment grade. Standard & Poor's, which also has a negative outlook, grades the obligations one level higher at CCC+.

"The question is do they go bankrupt before or after the holiday season," said Goldstein of CreditSights. "General consensus seems to be that lenders would rather hold onto the inventory as a collateral backstop."

Kmart Corp. filed for bankruptcy a day after missing a vendor payment in January 2002.

"In the retail space, it's very infrequently a debt coming due issue," Hebert, the Bloomberg Industries analyst said. "It's almost always vendors."

— With assistance from Lauren Coleman-Lochner in New York.

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