Radio Shack Getting Some Static From Its Market

Radio Shack Corp. (RSH.N) ran one of the more memorable Super Bowl ads built around the joke “the 80’s called, it wants its store back.” Apparently, they took the request seriously, as they announced on March 4 that they would be closing 1,100, or about one-fifth of company-owned stores. The market reacted harshly to the news, plummeting 17% to $2.25. We check out what’s on the wire for Radio Shack.

In the face of falling sales, quarterly revenue down $236 million compared to last year, negative earnings and quarterly EPS of -$1.46, Radio Shack is looking to consolidate its store base and improve operational efficiency by cutting low performing stores.

It is also targeting financial flexibility. CEO Joe Magnacca noted, “We completed a new financing totaling $835 million in early December. And this included a $585 million senior secured ABL credit facility, led by GE Capital Corporate Retail Finance, as well as a $250 million secured term loan, led by Salus Capital Partners.”

After completing this new round of financing, the retailer is already starting to break covenants. According to Vipal Monga, senior editor at the Wall Street Journal, the volume of store closures breaks the terms of RSH’s credit agreement, which requires a minimum of 4,278 stores. As a result, RSH will need to set aside $15,000 per store under the minimum.

Credit quality is clearly a concern as Radio Shack enters an inventory liquidation phase to cover the costs associated with the store closures. Total debt less cash is up 44% over last year at $434 million compared to $242 million. In the months leading up to the recent news, StarMine’s Combined Credit Risk model predicted trouble ahead.

RSH has the lowest score of 1 on the StarMine Combined Credit Risk (CCR) model, the most comprehensive StarMine credit model. Its calculation of the probability of default maps to an implied credit rating of CC to company debt and incorporates three other StarMine models (see below).

EXHIBIT 1. STARMINE COMBINED CREDIT RISK MODEL IMPLIED CREDIT RATING HISTORY

Source: Eikon, StarMine

1) Structural Credit Risk (SCR) model, which evaluates the equity market’s view of the company’s credit risk on a range from 1 to 100. Radio Shack’s score of 1 places it below 99% of its peers.
2) SmartRatios Credit Risk (SRCR) model, which uses the company’s profitability, leverage, interest coverage, liquidity and growth to model the credit risk. The increasing debt burden, reduction of cash, and lack of profits explains RSH’s score of 1.
3) Text Mining Credit Risk (TMCR) which scans transcripts, Reuters news articles, filings and select broker research to identify key words that may indicate negative news sentiment. Radio Shack again is at the lowest possible score of 1.

EXHIBIT 2. STARMINE COMBINED CREDIT RISK MODEL COMPONENT MODEL SCORES

Source: Eikon, StarMine

Short attention

Over the past year, StarMine’s Combined Credit Risk model along with its input credit models have placed Radio Shack in the bottom decile of North American companies. This highlights the financial stress and challenges new CFO John Feray will face. This is part of the reason shorting Radio Shack has become a crowded trade with 40.5% of shares shorted.

Radio Shack’s score of 1 on StarMine’s Short Interest (SI) model, the lowest score possible, shows that investor sentiment betting against the new management team’s ability to recover. However, StarMine’s Short Squeeze Indicator (SSI) model score of 95 predicts that any positive news will trigger price increases as shorts try to cover their positions.

EXHIBIT 3. BENCHMARK COMPARISON OF SHORT INTEREST AND INSTITUTIONAL OWNERSHIP

Source: Eikon, StarMine

It looks like Radio Shack is still twisting the dials as it seeks clear financial signals.

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