The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
On Thursday, RadioShack (NYSE:RSH) announced that it was unable to successfully negotiate consent from its lenders under the 2018 Credit Agreement and 2018 Term Loan to close up to 1,100 stores. The terms offered by lenders were not acceptable to the company. RadioShack may continue to negotiate with creditors but currently intends to continue with a revised plan to close fewer stores and pursue other cost reductions permitted by the current credit agreements.
RadioShack’s operational decisions are now being vetted by creditors. The “bright spot” of Q4:13’s earnings release was that the company intended to close up to 1,100 stores during FY:14, subject to the consent of its lenders. That last clause should send shivers down the spines of equity investors, as they are no longer relevant to management decisions — the creditors clearly are in control of the ship, and in our view, the ship is sinking. The company is already in negotiations to modify terms of a credit agreement that was put into place less than half a year ago. The current credit agreement allows for RadioShack to close up to 200 stores per year, or 600 over the life of the credit agreement. In our view, the operating situation at the company has deteriorated at an accelerating pace, making more store closures than anticipated required for positive cash flow.
Reiterating our UNDERPERFORM rating and 12-month price target of $1 as losses grow from declining CE sales and continued margin erosion, compounded by continued investments to spur growth. Our price target reflects our best estimate of the brand equity and going-concern value for the business (around $300 million), net of the company’s net debt.
Risks to attainment of our share price target include changes to the macroeconomic outlook, variability in new product release timing, the effects of competition from other consumer electronic and big-box retailers, and changes in consumer demand for consumer electronics.
Investment thesis: We believe that RadioShack’s core consumer electronics products drive foot traffic in its stores, leading to incremental mobility and other high-margin product sales. In our view, people go to RadioShack with the intention of purchasing a core product, and some end up buying a cell phone case or, now and then, a cell phone; we do not believe that RadioShack is a destination for cell phone purchases. RadioShack is a destination for CE, which has become an increasingly commoditized business, and one in which RadioShack has seen consistently declining sales.
In our view, declining traffic is the primary issue; if fewer consumers visit RadioShack for its core products, sales of its mobility and other high-margin products will continue to suffer. Company management has said in the past that RadioShack is a destination for smartphone accessories and other accessories; as difficult as this is to believe, even if it were true, we would not view this as an incremental positive due to the vastly lower gross profit dollar contribution compared to its declining CE and smartphones business. It appears that management is now facing a dwindling cash balance, compromised liquidity, and continuing market share losses. With that said, CEO Joseph Magnacca appears focused on returning to growth with what appear to be sound, traffic-driving ideas. However, we are skeptical that his efforts will bear fruit over the near term given the late stage of decline and what we consider to be lasting damage to the RadioShack brand.
Notwithstanding the attempt, we expect RadioShack’s core consumer electronics business to continue its slide, manifesting itself as slower foot traffic to RadioShack stores. While management appears committed to spending on new initiatives to recapture its lost customers, its liquidity continues to shrink. It appears to us that RadioShack is destined to continue to lose money, and we believe that the company’s spending on new initiatives and international growth will exacerbate its problems in the near term. We do not see a light at the end of this tunnel, at least until the company demonstrates that it can generate consistent profits and begin to grow its cash balance. We therefore rate shares UNDERPERFORM.
Michael Pachter is an analyst at Wedbush Securities.