American Apparel Has No Good Alternatives

Rumors swirl that ousted CEO may yet helm the company he founded.

Jul 1, 2014 at 10:29AM

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Source: Wikimedia Commons.

American Apparel's (NYSEMKT:APP) decision to oust its CEO for alleged "willful misconduct" might just result in the bizarre scenario of Dov Charney back at the helm of the fashion retailer he founded. Without many options open to it to stave off a default that could lead to insolvency or bankruptcy, the fashion retailer may need to issue a mea culpa and take back the executive that put it in this predicament.

There have long been whispers (and some shouts) about the executive's curious idiosyncrasies, which apparently then led to an internal investigation into his supposed shenanigans and then his dismissal earlier this month. Without specifying what exactly he did wrong, the board of directors fired Charney and replaced him with its executive VP and CFO. 

Naturally, Charney denies any wrongdoing and has fired back that he won't go quietly. U.K.-based lender Lion Capital, which owns 12% of the retailer's stock and is said to have been friendly with the CEO, has reportedly refused to waive the accelerated repayment of a $10 million loan that was triggered when the board ousted the CEO. The board has apparently called in its own backup in the form of Capital One Financial, which has debt considerations with the retailer that could be brought into play if Lion doesn't relent, and was reportedly in negotiations with both Lion and the board. A third lender, Cerberus Capital, was also reported to be willing to renegotiate terms of its loans with American Apparel.

Under Capital One's $50 million line of credit to American Apparel, of which $30 million has already been drawn, any default on one loan triggers a default of its credit line. The retailer warned that it risked bankruptcy or insolvency by firing Charney, alluding to the terms of its debt, but still felt it was necessary to let him go. Lion Capital, however, apparently on friendly terms with the executive, was rumored to be miffed at American Apparel's coyness about revealing his offenses.

Additionally, Charney has backing from hedge fund operator Standard General, which filed notice with the SEC that it would attempt to acquire 10% of the retailer's stock and lend it to Charney to gain even greater control of the company. Standard General's maneuver caused the board to adopt a one-year poison pill defense that would prevent someone who owned 15% or more of company stock from acquiring more, which it says isn't designed to preclude a takeover of the company, just to halt "creeping control."

However, Charney surprised everyone this morning, declaring he now owns almost 43% of American Apparel's stock, as the hedge fund bought a tranche equating to 17% of outstanding shares. Standard General bought 27.4 million shares last Thursday and Friday at a price of $0.715 a share, plus an additional 1.54 million shares yesterday at $0.91 per share.

While shares of American Apparel have nearly doubled since the firing, they closed down by nearly 7% yesterday on the possibility that Lion Capital has really called in its loan. Scrounging for cash as it is, the retailer has few options available to pay all the debt back. No one else would lend it money given that the company was already struggling before the drama unfolded, and raising funds via an offering could be difficult, as American Apparel is already approaching the ceiling of its authorized share count. 

While the retailer is putting up a brave front, saying it thinks it still has the resources on hand to pay back Lion Capital, it's rumored the company suggested to Lion over the weekend that they would take Charney back to make the problem go away.

Taking back Charney is an option, but certainly not a desirable outcome. With all the previous accusations of harassment and inappropriate behavior at this point, there would seemingly still be liability attached to his presence that would rule out a speedy acquisition by some potential buyer. And whatever the offense was that the board allegedly uncovered that finally drove them to take this action is still hanging over its head. However, if Charney goes over the 50% ownership threshold -- if he can convince another shareholder to loan him their shares and push him above the limit -- he could go so far as to move to rehire himself!

In short, the board has no one to blame for its predicament but itself. There were plenty of warning signs that its CEO's predilections were more than peccadilloes, and the longer it kept him on, the greater its own liability grew. Now having finally acted, it may have boxed itself into a corner from which it can't be extricated, and Dov Charney may yet become the once and future CEO again.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of Capital One Financial.. 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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