Already, there have been countless victims of the COVID-19 pandemic. Most of the companies whose doors have closed are small, private businesses. Some, however, are large national or multi-national firms that trade on the public markets. In the case of these larger firms, the typical track is a restructuring, normally through Chapter 11, aimed at eliminating debt and ensuring that the revitalized entity can survive once it's free from court supervision again. The latest casualty of the downturn has been health supplement retailer GNC Holdings (GNC).
A history of pain
There was once a time when GNC, like many firms, was a thriving enterprise. Those days are long past. In recent years, the company has seen its business tank. Between 2015 and 2019, for instance, revenue contracted significantly, falling from $2.68 billion to $2.07 billion. That's a drop of 22.9% in all. Poor store performance has naturally been a contributor to this decline, but it's not the only thing affecting the company's top line results. Because of poor results on its bottom line, management has had to resort to closing underperforming stores.
Back in 2015, the company ended the year with 9,090 locations worldwide. By the end of 2019, this figure had dropped to 7,532, a decline of 17.1%. The retailer's store-within-a-store business model held up a bit better at first, with the number of these locations with partner Rite Aid (RAD) locations climbing from 2,327 in 2015 to 2,418 by the end of 2017. Even that, though, was destined to be hit as time went on. By the end of 2019, the firm's unit count within Rite Aid locations had fallen 27.3% to 1,759. It is worth mentioning that the company's locations continue to shrink in count. As of its announcement regarding its bankruptcy filing, the company said it had only around 7,300 locations globally, including around 1,600 located within Rite Aid stores.
As you might expect, the decline in sales corresponded nicely with weak profits and cash outflows. In 2015, GNC's net income was $219.3 million. Each year on this front was volatile, but the latest fiscal year the firm lost $35.1 million. Its operating cash flows have also been volatile, but not to the same extent that its net income has been. Back in 2015, GNC reported operating cash flows of $354.5 million. Last year, this figure was little more than one-fourth of this at $96.5 million.
If the past few years have been painful for GNC, then the COVID-19 crisis has been downright unforgiving. Perhaps it wouldn't be appropriate to say that COVID-19 killed GNC. Rather, the pandemic's advent merely sped up the firm's failure. To see this, we need to only consider recent performance figures and actions taken by management. In the first quarter this year, management reported a year-over-year revenue decline of 16.3%. Its net loss of $15.26 million in the first quarter last year was dwarfed by the $200.58 million net loss the company incurred in this year's first quarter. Operating cash flow was far better off at -$12.09 million, but this was still materially worse than the $68.71 million in positive cash flow the company generated a year earlier.
Because of this rapid deterioration in its business, management announced on April 3rd this year some cost-reduction procedures. Specifics were missing, but in addition to planned employee furloughs, the retailer had instituted a hiring freeze, it eliminated its corporate meritocratic advancements, and it set out to cut costs in other unspecified areas. Twice this year, the company sought and received approval for delays in paying its term loan facility, its FILO credit facility, and its revolving credit facility. The last of these delays was supposed to expire on June 30th.
What we know so far
Based on all of this data, combined with the fact that management, in its latest quarterly earnings release, provided a 'going concern' warning, it shouldn't be all that surprising that GNC ended up announcing its intention to file for Chapter 11 Bankruptcy protection. Sometimes these processes go smoothly because the firm in question reaches agreements with many or all of its key lenders and other stakeholders. Other times, it can get messy. In the former case, the end result is often a faster time through the courts and an organized process where most parties know what they will receive. GNC did follow this route, in a manner of speaking, but it has added in a twist that most investors would be forgiven for not guessing.
In talks with a majority of its secured lenders, as well as with Harbin Pharmaceutical Group Holding Co. (an affiliate of one of its largest shareholders), GNC has struck a deal, tentatively, to sell off the business to Harbin in exchange for $760 million. So far, we know some details of the arrangement. For starters, the court will supervise the sale to ensure it complies with bankruptcy laws. Second (most as a matter of law than a matter of fairness to stakeholders), the parties involved have agreed that GNC may accept higher bids for its business and it may actively search for potential buyers in the process.
As part of this acquisition, Harbin will acquire all of GNC's assets. However, that's not all. The company agrees to provide other things as well, including a $400 million Bank of China credit facility that it will guarantee in the event that GNC cannot repay it. It will also offer a $210 million Second Lien Take-Back instrument that will pay out PIK (paid-in-kind) interest at a rate of LIBOR plus 6% per annum. This instrument will also include a 3% fee paid per annum on any outstanding amounts, which itself will incur interest at the same LIBOR plus 6%. This financing will be good for 6 years, while the $75 million in DIP (debtor-in-possession) financing provided by the firm to GNC will mature after only 6 months.
Beyond this, we don't really know much about the potential sale of the firm. We do know that if the sale cannot be completed in what management described as a 'timely manner', that the retailer will follow the second route of restructuring under its RSA (restructuring support agreement). Terms here have only just been made public as of this writing. We do know that over 92% of its term lenders and 87% of its ABL FILO lenders have agreed to the RSA's terms. In its filing, if GNC needs to go this route, the most senior class of lenders impaired will be its Tranche B-2 Term Loan lenders. They are slated to receive 100% of the common stock in the enterprise, minus the impact associated with MIP dilution and new warrants issued to parties that are junior to them. They will also receive $50 million in principal amount of the Exit FLSO Loans, as well as certain deficiency claims. Common shareholders, meanwhile, are expected to receive nothing.
The company has also, to maintain daily operations, received commitments for $130 million in financing. $100 million of this will come from its existing term lenders in the form of new DIP (debtor-in-possession) financing, while the other $30 million will come from modifications the company made in its agreement with its ABL credit lenders. In the process, management intends to continue investing in GNC's omnichannel and brand strategies, while accelerating its closures for between 800 and 1,200 locations.
Takeaway
Right now, things are not going particularly well for GNC. Right now, it's looking a lot like shareholders in GNC are set to receive nothing. Sure, the court could make changes to this arrangement, but investors should not bank on it. This does result in some speculative options, but the bottom line is that the risk here far outweighs whatever upside speculators might be able to get from the firm.
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