Bankruptcy Could Soon Be RadioShack Corporation's Best Option

RadioShack is teetering on the edge of bankruptcy. Its best move might be to jump in.

May 13, 2014 at 2:05PM

In early March, struggling electronics retailer RadioShack Corporation (NYSE:RSHCQ) presented a dramatic plan to cut costs by closing up to 1,100 stores. At the time, it seemed like "too little, too late," as the company had already burned through nearly all of its book value, and revenue had fallen well below what RadioShack needed to be profitable.

Still, the store closing plan was RadioShack's best hope for avoiding bankruptcy. Unfortunately, the company's secured lenders have vetoed this cost-cutting strategy in hopes of protecting their own interests.

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RadioShack's lenders have vetoed a plan to close up to 1,100 stores this year.

While RadioShack plans to make other cost reductions instead, it will have a hard time steering clear of bankruptcy due to its deteriorating business trends and the strict limits on store closures.

RadioShack's dilemma
Last year, RadioShack lost a stunning $400 million on revenue of $3.4 billion. Fortunately, the company was able to reduce its working capital by almost $400 million, primarily due to the collection of subsidies for smartphones sold in fall 2012. Otherwise, RadioShack would have been forced to draw on its credit line to stay afloat.

During the company's fourth-quarter conference call, RadioShack executives pitched the idea of closing up to 1,100 stores in order to cut operating costs and thereby reduce the company's losses. CEO Joe Magnacca said these stores were "lower-performing" and would lose money this year if they remained open. Others pointed out that some RadioShack stores were competing with each other because they are so ubiquitous in certain areas.

However, in December 2013 RadioShack closed an $835 million loan/credit line arrangement, and under the terms of that financing, the company needs lender approval to close more than 200 stores per year. Last month, The Wall Street Journal reported that RadioShack was having trouble persuading the lenders to sign on to its more ambitious store closure plans.

No dice
Last week, RadioShack revealed that its negotiations with the lenders had failed. The company stated, "The terms on which the lenders are currently willing to provide this consent are not acceptable to the Company." While RadioShack did not offer further details, it is possible the lenders wanted the company to use the cash generated by downsizing to reduce its loan balances.

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RadioShack had hoped to generate cash by selling the inventory of stores it planned to close.

The problem for RadioShack -- and its ordinary shareholders -- is that the lenders have their investment secured by the retailer's assets, primarily its inventory and receivables.

In other words, if RadioShack ultimately files for bankruptcy, the lenders will have first claim on the liquidation proceeds. This gives them very little incentive to compromise, even if their obstinacy means RadioShack must leave more money-losing stores open.

Next stop: bankruptcy court?
Unfortunately, the store-closing plan was RadioShack's biggest lever for staying close to breakeven on a cash basis in 2014. Under the revised plan to close just 200 stores, it seems very likely that RadioShack will run through its roughly $180 million in balance sheet cash before the end of the year. This will force it to draw on its credit line to keep paying the bills.

At some point, RadioShack's leadership team and board of directors may conclude that the company needs a more drastic restructuring (like the original store closure plan) to survive. The only way to make that happen without the lenders' consent is to file for bankruptcy protection. At that point, the bankruptcy judge would be the final arbiter of whether RadioShack should close more stores.

In this scenario, RadioShack shareholders would get little or nothing. However, the company would get some breathing room to regroup. Under the status quo, RadioShack could run out of cash within a couple of years, which would probably lead to its outright liquidation. Barring a miraculous sales recovery in the next few months, filing for bankruptcy may be the retailer's best move.

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Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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