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RadioShack bonds sending out distress signal

Posted 2/8/12

NEW YORK - Credit investors are paying the most ever to protect against a default from RadioShack Corp. on concern that the consumer electronics retailer’s emphasis on selling mobile devices will fail to revive its fortunes.

Credit swaps tied to RadioShack rose to a record $971,105 to protect $10 million of debt on Jan. 31, a day after it reported preliminary fourth-quarter profit that was less than analysts’ forecasts. The Fort Worth, Texas-based company’s 6.75 percent bonds due May 2019 have dropped 16 cents since they were sold in April to 83 cents on the dollar to yield 10.1 percent.

RadioShack, which opened its first namesake store in 1921, has seen its credit quality slide from investment grade in the past six years, with lackluster sales and growing competition from retailers such as Wal-Mart Stores Inc. and Best Buy Co. Its fourth-quarter earnings estimate of 11 cents to 13 cents per share is as much as 26 cents less than the analyst consensus before Jan. 30 as rising reliance on mobile devices and less- than-expected revenue from Sprint Nextel Corp. cut profits.

“In the past three years, the mobility part of the business has gone from about a 30 percent part of the business to a more than 50 percent part of the business, and that’s what is driving the whole margin erosion,” Mickey Chadha, an analyst at Moody’s Investors Service in New York, which downgraded the credit one level to Ba2 last month, said in a telephone interview. “That’s a tough business to be in.”

Implied Rating

Swaps on RadioShack implied a Caa1 grade as of yesterday, according to Moody’s Corp.’s capital markets research group, four steps lower than Moody’s Investors Service’s rating and three steps below the BB- from Standard & Poor’s. Moody’s, which cut RadioShack’s credit rating on Jan. 19, maintains a “negative” outlook on the company.

RadioShack’s almost 7,300 locations in the U.S. and Mexico, including mobile centers in Target Corp. stores, “give us a unique competitive advantage in scale, reach and convenience,” Eric Bruner, a spokesman for the company, said in an email. “Mobility products (smartphones, tablets, e-readers) are a fast growing segment within the consumer electronics industry. These products have high consumer interest and offer RSH the opportunity to drive traffic to our stores.” RSH is the company’s ticker symbol.

RadioShack’s fourth-quarter earnings prediction compared with an average 37-cent estimate of 19 analysts surveyed by Bloomberg. That’s down from the 51 cents per share earned a year earlier.

Repurchases Suspended

The report, in which the company also said it would suspend share repurchases “for the near term,” sent the stock tumbling as much as 30 percent, the biggest intraday decline in more than 30 years before it closed at $7.18 a share, the lowest since March 2009. RadioShack shares lost 83 percent of their value from the end of 1999 through January after accounting for dividends, while the S&P Midcap 400 index has returned 146 percent, according to data compiled by Bloomberg.

The company plans to release final figures and hold an investor conference call to discuss results on Feb. 21.

RadioShack is struggling to increase profitability in its latest incarnation. The company, known as Tandy between 1959 and 2000, started as a supplier of ship radio equipment and “ham” gear in the 1920s, according to a timeline on its website. It became a personal computer retailer in the late 1970s and started selling mobile phones and satellite television systems and service in the 1980s.

More Mobile

Mobility devices, including mobile phones, prepaid wireless air time, e-readers and tablet computers, accounted for 46.5 percent of revenue at RadioShack stores, kiosks and factories in fiscal 2010, from 36.5 percent in 2009 and 29.2 percent in 2008, according to a quarterly filing last April.

“We expect that consumers will increasingly want ‘choice’ at one convenient shopping location and by providing customers with a positive in-store experience and controlling costs throughout the organization, we can grow revenues, gross profit dollars and generate free cash flow,” Bruner wrote in the e- mail.

The shift is cutting RadioShack’s gross margin, which represents what it retains after the cost of goods per dollar of revenue. That measure fell to 35 percent in the fourth quarter from 41 percent a year earlier, as RadioShack earns less on certain smartphones, extended promotions and a still faltering consumer, according to the Jan. 30 earnings statement.

“We recognize that certain smartphones and other mobile devices, mainly tablets and e-readers, are a growing mainstay of consumer electronics purchases, and are significantly changing the margin profile of our mobility business,” Chief Executive Officer James Gooch said in the statement. “With this in mind, we are resetting our business expectations for 2012.”

Sprint Changes

The company’s fourth quarter results “are due in large part to the underperformance of the Sprint postpaid wireless business and reflect further unanticipated changes in Sprint’s customer and credit models,” RadioShack said in the statement. The shifts led to fewer new and upgrade activations and a decline in postpaid revenue from Sprint in the fourth quarter from the third quarter and year-earlier period.

Postpaid phones, sold with a contract with a base monthly amount, often include ongoing revenue for RadioShack.

Gooch said in an October earnings call that Sprint is the company’s “longest and most well-developed postpaid carrier relationship.” That means changes that prevent some customers from getting early upgrades affect RadioShack’s business.

Verizon Partnership

David Schick, an analyst at Stifel Nicolaus & Co., maintains a “buy” recommendation on RadioShack stock, saying the company’s partnership with Verizon Communications Inc. that started last year and the rise in Target Mobile centers have yet to affect results.

“If you add in businesses in a year in which business isn’t very good, you have a very sloppy impact and that’s what has happened to Shack,” Schick said in a telephone interview from Baltimore.

RadioShack has 4,670 company-operated stores in the U.S. and Mexico, 1,490 wireless phone centers in the U.S. and 1,100 dealer and other outlets worldwide, according to the earnings statement.

“There is a rationale for this company to exist, it has a niche market, which I think is always going to be RadioShack’s, a neighborhood-type store function,” said Sabur Moini, a money manager who helps oversee about $2 billion of high-yield debt, including RadioShack debt, at Los Angeles-based Payden & Rygel. “They’ve got caught up in what’s been a fairly competitive electronics environment especially in the wireless side, and the question is does that get worse or does that stabilize?”

‘Little Patience’

CreditSights Inc. analyst James Goldstein cut his recommendation on RadioShack’s 6.75 percent notes to “underperform” from “market perform” on Jan. 31, according to a note that day.

“At this point, the market seems to have relatively little patience for consumer electronic retailing stories,” Goldstein wrote, citing the drop in the bonds.

RadioShack’s $324 million of the debt, which matures in May 2019, has dropped 7.38 cents since Jan. 27, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The yield, the highest since the securities were issued, is hovering between the 8 percent on all B graded bonds and 12.7 percent on debt graded CCC and lower, Bank of America Merrill Lynch index data show.

AAA Rating

“This is a company that has kind of been teetering on distressed levels for quite some time,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. “Investors are a little more cautious these days, especially when you look at electronics. It’s a changing sort of environment.”

S&P, which ranked RadioShack predecessor Tandy as high as AAA in 1983, cut the company to BB- in November with a “stable” outlook, citing a “weak” business risk profile based on “short product cycles, the highly competitive nature of the retail consumer mobility industry, and the company’s vulnerability to weak consumer spending because of the fragile economy.”

The retailer lost its investment-grade credit rating from S&P in 2006 and from Moody’s in 2007.

“We currently have significant liquidity with our approximately $590 million cash position at year-end and our available credit facility,” Bruner wrote. “We are confident that our balance sheet is appropriately configured to allow us to accomplish our business goals.”

‘Market Has Shifted’

RadioShack had $666.4 million of long-term debt, it said in its most recent quarterly filing in October.

“The market has shifted on how people buy electronics and media,” said Marc Gross, a money manager at RS Investments in New York who oversees $3 billion in fixed-income funds. “The same market forces that brought down Circuit City are still at play,” he said. Gross said he doesn’t own RadioShack debt.

Circuit City Stores Inc., the 59-year-old seller of televisions and computers, filed for bankruptcy protection in November 2008 after losing market share to Best Buy Co. and Wal- Mart Stores Inc. while Amazon.com Inc. and other online retailers undercut it with lower prices.

The cost to protect RadioShack debt from a default for five years was 971 basis points on Jan. 31, according to data provider CMA. The contracts, which typically rise as investor confidence worsens and fall as it improves, declined to 926.6 basis points yesterday.

Good Liquidity

Default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

While RadioShack is suffering from eroding margins, its current liquidity “remains very good,” preventing further downgrades last month, Moody’s Chadha said. Its next maturity, $375 million of convertible debt, is in 2013 and the company has enough cash to pay that off, he said.

The retailer’s adjusted ratio of debt to earnings before interest, taxes, depreciation and amortization is likely to rise above 5 times after the next earnings report, which isn’t typical for a Ba2 grade, he said.

“The biggest challenge for Radio Shack is to stay relevant in the face of some stiff competition and that’s a big challenge,” Moody’s Chadha said. “They need to conform their cost structure and their capital structure to more of a business model that supports a much lower gross margin business model than what it used to be historically.”

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