James Mammarella

LNT’s Deadweight Interest
April 23, 2008

Yesterday, I highlighted some basic retail operations metrics at Linens ’n Things. We saw that in the two years under its Apollo Management ownership, the profit gap between the company’s gross margin and its overhead has flipped: from positive 330 basis points in 2005, to negative 520 basis points in 2007.

Today we’ll look at another fundamental that has gone out of whack: interest expense.

This solitary line item has in the last two fiscal years together, contributed $186.6 million of downside, or 47.1% of its two-year combined net loss of $396.5 million.

Making interest payments is the direct cause of nearly half of LNT’s losses.

That wasn’t exactly part of the plan – but it certainly wasn’t unforeseen. The transaction forged by Apollo Management to take LNT private at the beginning of 2006 was built upon a $650 million debt issue. Higher interest payments naturally go hand-in-hand with higher debt.

Quoting directly from the March 20, 2008 10-K filing by Linens ’n Things:

“The Company’s financial performance is significantly affected by the Transactions. The incurrence of long-term debt to finance the Transactions results in materially higher interest expense…”

Indeed, the 10-K shows LNT’s pre-acquisition, 2005 interest expense was $4 million. That ballooned to $79 million in 2006, and then to $108 million last year – a quantum leap from 0.2% of sales to 3.9% of sales.

Net interest expense:

2005: $3.97 million     2006: $78.94 million     2007: $107.64 million

This is an extreme departure for the 589-store retailer. LNT’s net interest expense was $3.36 million in 2004; it was $3.83 million in 2003. It was, in a word, manageable.

At the new LNT, interest payments are due quarterly on the $650 million in debt notes. The rate is reset quarterly; as of Dec. 29, 2007 the rate was 10.9%. Ouch.

Interest expense – by which a company gains nothing, except the possibility of using lots of ready working capital in order to build and grow – has zoomed out of its place in the LNT books.

But all that debt has not fueled big LNT growth.

Retail sales:

2005: $2.69 billion     2006: $2.82 billion     2007: $2.79 billion

In the years when it kept interest expense below $4 million, LNT added 50 net new stores annually. That growth rate has been cut in half – the new LNT operates about 55 more stores now than it did in 2005.

Actually, the company has ceased to grow at all.

LNT is loaded up with junk bond debt, with the note holders reportedly trading the bonds at less than half face value – but relentlessly demanding payment. It was the April 15 non-payment of $16.1 million in quarterly interest that started the current uproar.

The banks supposedly will hold off until mid-May before they make any move on the inventory and other assets that secure their $700 million credit facility – under which LNT said it had $303 million in excess availability as of Dec. 29. In other words, LNT has already borrowed hundreds of millions on the credit line, which originated last October.

The main chunk of liquefiable value at LNT is tied up in blenders, toasters and home textiles on shelves and in warehouses.

The banks are first in line for those assets. Apollo and fellow note-holders come second in line. What they need: fresh cash to keep Linens ’n Things afloat. Source: unknown.

Posted by James Mammarella on April 23, 2008 | Comments (0)