Special Report
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In recent years, the folks over at Guitar Center haven’t been… overly chatty with MMR. It wasn’t a policy directed solely at this publication – far from it. For a good while there, it just so happened that GC’s de facto procedure when it came to trade media was: say little, or say nothing.

That all began to change earlier this year, though.

Almost immediately after the appointment of Mike Pratt as CEO this past March, Guitar Center’s reps began (literally) returning calls, with high ranking officers making themselves available for comment on the issues of the day.  Case(s) in point: when there began to be rumblings about the possible unionization of the NYC Guitar Center store, Gene Joly – then executive VP of stores – hopped on the phone for a detailed and frank interview (more on unionization and Joly later) which appeared in our June issue; When Standard & Poor’s cut Guitar Center Holding Inc.’s credit rating from B- to CCC+ in early June, GC was quick to reach out and note that earlier that very same week, Moody’s Investors Service considered Guitar Center to be “Stable” and their rating was “Unchanged.”

In October, this shift towards open lines of communication took an even more meaningful and measurable step forward with GC making a number of key executives freely available for one-on-one, face-to-face conversations.  No questions were “off limits” and the responses given were expansive and candid – sometimes surprisingly so. Read on to learn more about what’s going on at Guitar Center these days and, for the hardline critics out there, to perhaps learn that “the big, bad big-box” isn’t necessarily the enemy.

 

New Guy, New Ideas

So who is Mike Pratt? Prior to succeeding GC’s interim CEO, Marty Hanaka, this past spring, Pratt had been the president and COO of Best Buy Canada and Future Shop for nearly five years, though his career with Future Shop began more than 20 years prior, as an in-store sales associate. He has a well-earned reputation for being a forward thinking leader, especially with respect to opportunities brought about by emerging technologies (during his tenure at Best Buy Canada, the operation drastically expanded its e-commerce and online presence, and also grew from 165 to 275 retail outlets).

Guitar Center’s VP of Communications & Corporate Affairs, Christopher Ian Bennett, served under Pratt at Best Buy Canada and says, “Having worked with Mike Pratt for many years, I’ve become very familiar with his style of leadership and his approach to strategic planning.  He’s probably put more air miles between him and our Support Center in LA in the last six months than most CEOs might do in two years.  Mike’s a front-line leader, in that he started his own career in retail 20 years ago exactly where our GC associates are today – in the stores, helping our customers. They drive the business and he believes strongly that’s how we’re going to be successful in 2014 and beyond.”

“Since Mike Pratt joined, it’s just been really fresh and exciting around here,” agrees Kevin Kazubowski, GC’s senior vice president of stores. “The overall attitude is that we need to examine every single thing we do at Guitar Center and if it’s not perfect, then let’s change it. It really is all about helping people make music.”

Of course, it’s easy to talk a good game. Is anything tangible actually happening to back up all the hype?  In fact, yes.

Most MMR readers are familiar with the stereotype of the know-nothing, late-teens GC sales clerk whose ineptitude frustrates legit customers for a few weeks until he or she quits/is fired and is then replaced by another, equally ephemeral hire. It’s a myth based in reality, but it turns out that “reality” is more than a little bit outdated. Employee turnover at Guitar Center stores has decreased nearly 40 percent since 2009 and GC continues to make significant investments into employee training and outreach.  “It’s all about training, development, leadership, and an intense focus around people,” says Dennis Haffeman, executive vice president, HR.  “We’re aligned around having opportunities for our employees. I’d like to improve the environment, so that we’re not just one of the top MI places to work, but one of the top places to work, period.”

“When you grow as fast as we did back in the ‘90s, it’s inevitable that the level of talent isn’t going to be the same at each location,” concedes Kazubowski. “We recognize that and we’re fixing it. What worked in the ‘80s doesn’t work in 2013. I want to turn [being a sales associate] from being a job into being a career. I’m trying to get belly-to-belly with our associates and create independent thinkers with benefits that cascade down to the customer. What can we do to get the associates excited? It’s about inspiration – not inspection.”

Sounds good. But if attention to employee satisfaction is so crucial to Guitar Center, what was that whole unionization thing about…?

 

The ‘Unionization Thing’

“I think there were and are individuals out there spreading misinformation,” says Haffeman. “You look at Occupy Wall Street, organizing fast-food workers to strike – the message people get bombarded with is, ‘Join the union, you can make more money!’ It’s an appealing message. But after Manhattan did vote to unionize, look at the pushes to do the same elsewhere: Brooklyn, Queens – at the end of the day, they all said ‘no.’ [Though efforts to unionize the Brooklyn and Queens GC stores failed earlier in the summer, employees at a Chicago GC did vote to form the company’s second-ever retail union in early August, 2013. – Ed.] I’m not – we’re not – ‘anti-union.’ I’m pro-associate.”

Ok, but… weren’t there complaints about sales quotas and employees not being able to make a living wage? “It’s absolutely not about metrics,” says Kazubowski. “It’s about behaviors. We’re not in the practice of docking commissions and when that has happened it’s not about not meeting a quota, it’s about not meeting service standards.”

“The RWDSU [Retail Wholesale and Department Store Union] has their own agenda – of course they do – and they’re a business,” says Haffeman. “It’s in their interest to try and attempt an organizing drive.”

Kazubowski points to improvements GC has already made specifically to make the employment experience better for associates – additional paid holidays, wage increases, hiring Global professional services firm Towers Watson as consultants – and says to any doubters out there (on Guitar Center’s payroll, or otherwise), “Hang back. Good stuff is going to happen!”

 

Debt, Bain, & Profit

Unquestionably the primary driver of rumor and speculation regarding Guitar Center is the organization’s perceived debt and the fear that, if GC is losing money for Bain Capital (who purchased Guitar Center Holdings, Inc. in 2007), then the whole chain could go the way of MARS Music. I write “fear” not because everyone out in MI Land is a big GC fan, but because – whether you like the company or not – if Guitar Center were to go under, we’d all be in for a world of trouble.  MARS, at its peak, fielded 49 stores – a far cry from GC’s current tally of 253 – and when that business was liquidated, 19 of MARS’ top 20 unsecured creditors were MI vendors, with claims in excess of $13.6 million, according to bankruptcy filings.

Any hiccup – real or perceived – regarding GC’s fiscal health sets the blogosphere a-twitter. Legitimate news sources and consumer message boards, alike, post ominous headlines such as, “Bain Capital’s Guitar Center Hits Rough Patch” (Reuters, June 12 2013) or, “Life Support: How Long Until They Pull the Plug on Guitar Center?” (The Tone King, November 5 2012).

“People unfortunately don’t do the research,” says Tim Martin, Guitar Center’s CFO. “Bain is a very smart group of investors.”

He says the firm knew what they were getting into. “Quite frankly, they bought Guitar Center at the height of the market, at the highest possible price they could, so it’s not going to be simple, but if they really wanted out, they could have gotten out years ago. And I will tell you: if they were at all concerned about the future of the business, they would not let me spend over $60 million a year on capital expenditures. That’s not the way business is run. Anyone who tells you otherwise is crazy.”

Speaking of Bain, why are folks so suspicious of the group? “People love to bash Bain – Mitt Romney made that very simple,” Martin asserts. “It’s a nice headline and it gives people attention. I’ve never heard anything come out of Bain that would be detrimental to our employees or our customers. They’re supportive of long-term growth and excited about the future of the business.”

 

Not Too Big to Fail – Too Profitable to Fail

Here’s the thing: Big business can be confusing. It’s not surprising that to an outside observer it’d seem incongruous that GC is attached to an extremely large amount of debt (often assumed to be in the neighborhood of $1.3 billion), while simultaneously opening up gleaming new retail stores at an impressive clip (15 in 2013, alone).

In the spirit of saving the best for last, Tim Martin’s detailed explanations, reactions, and observations close out this look under the hood at Guitar Center:

“I think that it’s important to separate the business from the capital structure. That’s a unique way to look at things, but I think it’s really important. In looking at the business you have to realize that last year the business made over $200 million dollars in EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). It’s the operations of the business that generate positive returns on investment.

“When you look at the pure financials and people look at what we have to file with the Securities and Exchange Commission – which is absolutely right in accounting vernacular – it includes non-cash items like depreciation, amortization of intangibles, and it also includes a pretty sizable interest payment. If you own a house, you pay interest on that house. Well, the people who own the business also pay interest on the business. That doesn’t mean that the house isn’t worth a lot of money, or even generating positive returns on investment if you’re renting it. It just means you have a related cost with that investment.

“We have 253 stores, as of now, that are all cash flow positive. We have no stores, as of the last time I checked, that are not making money.  That includes Music & Arts stores. There are very few retailers out there who can say that sort of thing. So, the whole ‘GC is going out of business’ philosophy is flawed in many, many ways. At the end of the day, if you have stores that are making money, there’s no way they’re going out of business. You can separate the ownership from the operation and say that the operations of the business aren’t going away. It’s not like we’re going to disappear, it’s not like customers aren’t going to be able to shop at Guitar Center, because nobody in their right mind would close stores that are making money.

“There is a capital structure discussion that’s on the other side of the coin.   That’s ownership by Bain, that’s ownership of debt by one large entity who owns about $830 million dollars [of GC] who are long-term investors and very good partners, and then there’s a conglomerate of 30 to 40 banks depending on the time of year that own about $620 million dollars as well. Those are numbers that move around a little bit, based on interest payments.

“The reality is, if interest payments ever became a problem for the company and we were not able to make a payment to this entity, there is absolutely no way they would ever let something happen, because the guys who are above them in the capital structure, who own less of the debt than them, would get control.  There’s no way they’re going to let that happen.

“That’s the reality of what a leveraged buyout is. Somebody borrowed money to buy a business that’s going to generate cash flow. They do what they want to do with the business – dust it off, fix it up – and then you take it public again and you use those proceeds to pay off the money you borrowed before. You don’t use the operating proceeds to pay off the debt – you use the operating proceeds to pay off the interest on the debt. Nobody ever thought we would actually pay off our debt with operational proceeds. There are a lot of people who say, ‘They can’t service their debt load,’ Well, duh! We never intended to. The owners never bought Guitar Center thinking, ‘We’re going to use the $200 million a year to pay off the debt, they said, We’re going to use the $200 million a year to reinvest in new stores, to grow the business.’

“I think the noise around our debt issue is overblown. At the end of the day, I don’t have a material debt payment that we have to make for a number of years. The good news is it’s a lot of speculation, a lot of people who have an agenda, who’d like to see Guitar Center go away. The reality is, even if for some reason there was a financial distress scenario on the capital structure side of the house, the stores are all profitable. There’s no bankruptcy court in a million years that’s going to shut down profitable stores. That’s not how bankruptcy courts work. It’s not even that we’re too big to fail – we’re too profitable to fail.”  



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