Termsheet: When retailers are on the run

While much attention has been devoted to problems in the energy sector in recent months, retail hasn't gone unnoticed by those on the lookout for distressed investment opportunities. As oil and gas companies have been battered by low energy prices, so retailers have had to adapt to a world where the customer – and the competitor – is increasingly online. 

For Sports Authority, online shoppers were just one of the factors that led to the sporting goods and accessories retailer's demise in May, but its final few months provide an example of the kind of opportunities available to distressed lenders.  

In November 2015, in search of backing to help the company stock up for what it hoped would be a lucrative holiday season, Sports Authority turned to TPG Specialty Lending. TSLX, which declined to comment for this story, worked with others under TPG's Special Situations Partners platform, to provide a $70 million portion of a $95 million 'first in last out' term loan to Sports Authority.  The facility is understood to have an interest rate of Libor plus 726bps and 200bps upfront with call protection. 

FILO loans are generally used to supplement existing senior loans and are so named because the money is advanced up front and lenders are paid out after others higher in the capital structure. The Sports Authority investment had a 9.4 percent interest rate and sat within the retailer's revolving term loan.  

However, hopes of a merry Christmas were dashed by a mild winter and poor fourth-quarter sales. By March, Sports Authority was filing for bankruptcy with the FILO loan rolled up into a $595 million debtor-in-possession financing understood to have an interest rate of Libor plus 896 bps. Unable to find a buyer, the retailer sold its inventory to a joint venture of Gordon Brothers, Hilco and Tiger Capital, which started liquidation sales in May with the proceeds used to pay back the FILO loan and other debt. The rest of the payment will be made by the liquidators in mid-July.  
In addition to outstanding trade debt from suppliers such as Nike, Under Armour and Asics, the company's unsecured creditors included GSO, Crescent Capital Group and Partners Group, among others.  

Sports Authority was $1.1 billion in debt when it filed for bankruptcy, and it's these increased debt levels that have helped to make liquidations in the retail sector more common, says David Berliner, partner in the business restructuring and turnaround practice at BDO.  

Citing the likes of Wet Seal, RadioShack and others, Berliner says that resulting payments often leave little capital for making the kinds of changes to businesses that might allow them to continue operating.  

“Today, retailers have so many levels of debt that it becomes very, very difficult to structure something that can work when they get into trouble, because there is no room for error,” he says. 

“The lenders are lending into situations where, as long as they're protected, I don't think they worry as much today if the company ends up having to file for bankruptcy, as long as they feel they have a reasonable prospect of getting their value back.” 

That is certainly the impression given by TSLX's co-chief executive officer Josh Easterly on his firm's first-quarter call in May. He said that rather than demonstrating any belief in the future success or failure of an individual retail company, TSLX's loans into the sector were informed more by consolidation among lenders, bank deleveraging and the resulting lack of capacity in the asset-backed loan market.  

“We underwrote our original investment in Sports Authority with some expectations of a bankruptcy or liquidation event, but believed that the company's working capital assets provided substantial downside protection to our position,” he said.  

In addition to the Sports Authority loan, TSLX has also originated FILO loans with similar interest rates to Destination Maternity and Toys “R” Us. 
FILO loans often have similar pricing to mezzanine packages and have become more common in recent years as lenders understand more about the liquidation value of inventories and the timeframe in which they will be repaid.  

This greater understanding of inventory liquidation value is credited to a group of professionals affiliated with Gordon Brothers Retail Finance going back to the late 1980s. Before the Boston-based company was established to focus on improving the assessments used in liquidations, valuations of inventories carried out by banks were more conservative and often inaccurate. 

“We team up with other lenders in the space and do directly-originated bespoke transactions in the retail space,” Easterly said on the May call. 
“We think that will offer a very good risk return; that is asset-backed lending in nature.” 

National Securities analyst Christopher Testa says the FILO loan extended to Sports Authority showed the strength of TSLX's underwriting process. The TSLX team had an understanding of how the bankruptcy process would play out with regards to their loan, Testa says.  
“Few other market participants would have the knowledge of retail ABL coupled with the size required to complete the Sports Authority transaction.” 

As investors continue to search for opportunities lending to retailers in danger of default, TSLX's FILO loan to Sports Authority provides an example of what can be available to those able to see the value within a failing business. 

1987 The Sports Authority is founded in Fort Lauderdale, Florida.  

1990 Kmart buys the retailer for an undisclosed sum.  

1995 Sports Authority goes public.  

2003 Original company is acquired by Gart Sports and becomes a subsidiary called TSA Stores, Inc. Gart Sports is re-branded The Sports Authority.  

2006 The Sports Authority taken private for $1.3 billion by Leonard Green & Partners.  

May 2015 The company extends maturity on $350 million in mezzanine debt from 2016 to 2018.  

November  Sports Authority secures bridge financing from TPG Specialty Lending.  

January 2016 The retailer misses a $20 million interest payment on a loan.  

March Sports Authority files for bankruptcy and announces plans to close 140 of its 463 stores.  

May 23 After failing to restructure or find a buyer, Sports Authority announces it will close all remaining stores.  

May 26 A joint venture between Gordon Brothers Group, Hilco Merchant Resources and Tiger Capital Group begin going-out-of-business sales at all Sports Authority retail locations.  

August Out-of-business sales scheduled to end.