American Apparel is trading at $1.00 despite increasing Same Store Sales for the past 18 months in a row. The company has stated in the past announcements if store sales continue to trend higher, the company will refinance their existing high cost debt which should trigger significant upside to the price as bankruptcy concerns are taken off the table. "Assuming our sales and EBITDA growth hold through the 4th quarter, we believe that we will be in a position to refinance our existing high cost debt and reduce our cost of capital." from the CEO Dov Charney.
For a comparable story, the share price of Zales (ZLC) appreciated from $3.16 to $6.82 close price as of 11/12/12 an increase of ~115% from the day the company announced a refinance of their existing high cost debt. Here's a link to the 7/25/12 PR for ZLC: http://phx.corporate-ir.net/phoenix.zhtml?c=64546&p=irol-presentations
Notice also the high volume and large price appreciation the day of the announcement as investors were waiting for confirmation before establishing positions.
Reason for Discount:
Like many companies, American Apparel took on large amounts of debt in the 06-07 bull market and suffered material slowdown in business during the 08 recession. Combined with some CEO "impropriety" and labor/immigration issues at their factory, caused significant stress and lack of confidence in the stock and management team.
The company has an $80MM secured credit facility with Crystal Financing and $127.6MM with Lion Capital at 18% interest!! Any opportunity to reduce this debt would result in significant leverage to the equity price. The total interest expense was $38MM.
ROTH is the only analyst that covers the stock and has a Buy rating and at a $3 price target. The analyst believes the companies investment in CAP EX will increase margins and lead to 2013 EBITDA of 65MM. While this is a benefit and we agree it is a long, my feeling is the catalyst will be debt refinance.
Back of Envelope Calculation:
Assume the company can reduce Interest Expense by 5MM to 33MM annually. Current Market Cap is 109MM and EBITDA (ttm) is $11.5MM so its trading at 9.5 EBITDA (ttm). Using analyst 65MM 2013 EBITDA estimate and a 30% tax rate and an INCREASE in shares to 148MM (currently 106MM) the 2013 EPS increased from 0.12 to 0.15
((65 - 38) * 0.30) / 148 = 0.12
((65 - 33) * 0.30) / 148 = 0.15
The other assumption is no change in depreciation or amortization however the company has been closing stores, going from 280 to 250 stores.
Additionally it is likely that the multiples assigned increase at least 1x turn as fears of bankruptcy are taken off the table which should lead to further upside.
I spoke with management after their 11/14 earnings report and it was quite positive. Biz trends are doing the right thing. Sandy probably not as big an impact as thought but accelerating investments in advertising and technology to take advantage of strong biz trends. Hence the reduction in EBITDA guidance top end from 44 to 40MM
Most important, specifics were provided on refinance activities; it is likely that a lender has been identified and specific terms have been ironed out. A minimum hurdle of 35MM EBITDA was provided to ensure refinancing goes through which seems very attainable. The tenor and an interest range have also been closely defined. This gives me confidence that a refinance WILL happen, still a question of when but I think Q4 or Q1 2013 are most likely time period.
There is risk of dilution due to warrants however the exercise prices of these warrants range from $3.25 to $5.25
Management still has a lousy reputation though the CFO is making strides in that regards. The CEO is extremely large holder, owning 40MM+ shares. Normally it is good to see the CEO incentive however Dov Charney has proven to be somewhat "eccentric".
This is not a critique of the fashion trends at APP or retail in general, there is a very real risk that the overall trend of sales could decrease due to fickle nature of the consumer. If so, management will probably miss it's stated EBITDA targets.