Termsheet

When the music’s over…

…turn out the light, sang the Doors. For music, film and games retailer HMV, a burdensome debt load and weak performance brought the curtain down on more than 100 years of trading. But the acquisition of its debt by Hilco could pave the way for a positive outcome, writes Oliver Smiddy  

Another day, another retail casualty. When HMV finally yielded to the inevitable and entered administration in January, it seemed to spell the end for a company that traces its roots back to the 1890s. Its name and logo, for example, were derived from the Francis Barraud dog-and-gramophone painting “His Master’s Voice”, bought in 1899 by the company that would later become HMV.

Administration was announced in January. As many as 50 suitors, including a large number of distressed investors such as the UK’s Better Capital and Endless, appeared to see value in the iconic company, and not just from its substantial real estate portfolio.

Just seven days later, Hilco, a restructuring firm specialising in distressed retailers, won the bidding war to acquire HMV’s debt from eight banks including RBS and Lloyds Banking Group. Hilco’s offer of around £34 million ($52.1 million; €38.9 million) was reportedly lower than some rival bids. But informal (albeit not legally-binding) assurances from Hilco that it would strive to keep the company going swayed the banking syndicate, which feared reputational damage should a well-known high street chain be carved up and sold off and its 6,320 staff made redundant.

Retail analyst Nick Bubb tells Private Debt Investor: “The physical market for entertainment is still pretty big, despite the digitalisation of many products. So I can see why Hilco is interested in the rump of HMV, not least as it has shown with HMV Canada [acquired from HMV Group in 2011] that there is life after death.”

The acquisition of HMV’s £176 million debt gave Hilco de facto control of the company. Negotiations with the company’s administrators as to how to restructure the company are ongoing. Hilco declined to comment, while administrator Deloitte’s restructuring team were unavailable for comment at the time of going to press.

Under-paced and over-geared  

It’s no secret that retailers generally have been squeezed in the economic downturn as consumers’ spending power has been eroded. In addition though, HMV was dealt a grievous additional blow by a growing trend towards online music and computer game sales at the expense of traditional high street retailers.

“HMV didn’t adapt its business quickly enough to the decline in the CD and DVD market: it should have moved more quickly into technology and shouldn’t have frittered around with things like cinemas and live music,” Bubb says.

Performance since 2011 had declined sharply, with revenues more than halving from £1.88 billion in the 2008 financial year to £873 million in 2012, according to data provider Debtwire. HMV’s reported EBITDA collapsed from £108 million to £13.4 million over the same period.

If that makes grim reading, the debt section of its balance sheet is worse. Total debt rose from £35.5 million in 2008 to £193 million. HMV’s total debt to adjusted EBITDA ratio moved from 0.33x to 8.52x in those five years.

The company recognised it had a problem and took steps to address it last year. One of those steps involved an ‘amend-and-extend’ to its £220 million senior bank facility last April. That comprised a £60 million revolver, a £70 million term loan A and £90 million term loan B, whose maturities were pushed out to 30 September 2014, or September 2015 if certain conditions were met. That senior facility pays interest at LIBOR +4 percent.

Total net debt at 27 October 2012, according to Debtwire, stood at £171 million (£200 million total debt less cash), equating to 5.69x leverage. A few months later, management was replaced.  

It had also been shedding assets. It sold book retail chain Waterstone’s to A&NN Capital Management for £53 million in May 2011, the Hammersmith Apollo venue to STAGE C for £32 million 12 months later, and finally its live music division MAMA group, including its 50 percent stake in Mean Fiddler, to LDC for £7.3 million in December 2012.

None of these measures helped to stave off the threat of insolvency. In December, HMV warned that due to weak trading in the half year to 27 October, it faced breaching covenants in January this year. On 14 January, its shares were suspended after it announced it would be appointing administrators.

On 22 January, Hilco’s UK team announced in a statement that it had acquired HMV’s debt from its lenders, but had not bought the business itself. “Hilco believes there to be a viable underlying HMV business and will now be working closely with Deloitte who, as administrators, are reviewing the business to determine future options,” the statement said. 

Hilco reportedly offered £15 million in cash for the debt – more than a 75 percent discount to face value – with a second payment of around £19 million contingent on the company returning to profitability.

 It’s been a busy period post-acquisition. Deloitte announced last month the closure of 66 loss-making stores from its overall portfolio of 220 outlets. The 66 stores together employing 930 staff.

Nick Edwards, one of the Deloitte administrators alongside Rob Harding and Neville Kahn, said in a statement: “We have now completed a review of the store portfolio and have identified 66 loss making stores for closure.  This step has been taken in order to enhance the prospects of securing the business’ future as a going concern.”

In addition, HMV shut down its website and made around 60 redundancies at its head offices, including replacement chief executive Trevor Moore. He had been in post for just seven months.

Significantly, it has also agreed terms with its principal suppliers to secure the continued delivery of major film, music and gaming releases. Suppliers like Sony and Universal Music are understood to be keen to back a high street retailer as a rival outlet to supermarkets and online retailers.

Any sale would now require assent from Hilco. Its acquisition of HMV’s debt puts it in an influential position, and could prove to be enormously lucrative if performance at the group improves. If so, it would mark another success for the firm, demonstrating that with the right skillset, distressed debt investors can deliver outsized returns.