American Apparel Is Indebted to Private Equity for Salvation

The retailer may have been tossed a financial lifeline, but it won't save the company's current form.

Jul 8, 2014 at 2:04PM


Source: American Apparel.

Although Lion Capital has apparently called in its $10 million loan to American Apparel (NYSEMKT:APP) due to the firing of CEO Dov Charney, it appears the retailer won't default on the repayment. Instead, private equity firm Standard General will pay the debt, which would have caused American Apparel to default on a separate $50 million loan from Capital One Financial.

The strategic battle for control of American Apparel took another bizarre turn two weeks ago after Standard General said it had acquired an additional 27 million shares of company stock and would loan them to Charney, bringing his stake in the retailer to 43%. But in exchange for the loaned share, Charney turned over to the PE firm his voting rights on all of his stock unless he gets its approval of his votes -- in essence giving the hedge fund the controlling say in all decisions.

According to the Financial Times, the retailer has been negotiating to have Standard General take control of the company in exchange for a lifeline worth $20 million to $25 million. That would be more than enough to pay off Lion, whose loan required that Charney remain in charge of the company, as well as provide assurances to other lenders that the company wouldn't immediately go under.

Charney was terminated two weeks ago after the board of directors said it had conducted an internal investigation into allegations of impropriety that uncovered new evidence against the executive. Charney maintained his innocence, and many wondered what new allegations could finally have forced the board to act compared to other charges that have been leveled against him in the past.

Although the board has failed to reveal any information about its actions, it is reported to have hired FTI Consulting to delve further into Charney and supposedly will reveal all in the future. Standard General itself is awaiting the conclusion of the investigation to determine what, if any, role Charney will have in the company going forward.

Both sides in the ordeal have left investors scratching their heads. For years there have been allegations of sexual harassment, along with settlements paid from lawsuits filed. The board has always looked the other way. That it suddenly decided to move this time, and imperil the company's actual existence because it triggered the demand for repayment by Lion Capital, has now led to a shareholder lawsuit against both Charney and American Apparel.

On one hand, the lawsuit charges that the executive engaged in "egregious" conduct, including misuse of corporate assets and violating the company's sexual harassment and anti-discrimination policies. It also says the board was derelict in its fiduciary duties by "turning a blind eye" to his conduct. Failing to hold Charney accountable for his actions, including when the company had to pay out money for his transgressions, damaged American Apparel's "operations, financial position and reputation," according to the lawsuit.

Standard General is said to be looking to replace nearly the entire board with new faces, except for two people, including the individual who stepped in as chairman when Charney was fired.

It seems clear to me a clean sweep is needed at this company. The founder, for all his idiosyncrasies that may have catapulted American Apparel to a unique spot in fashion, has become a liability and a drag on company performance. And the board has seemingly been complicit in the problems that arose. A new direction is needed. The private equity firms that have forced the retailer's hand lately seem not aligned so much with Charney against the company, but rather are interested in protecting their and other shareholders' investments from a dysfunctional situation.

American Apparel may yet emerge from this morass, but it likely won't be the same company it was before. And despite the retailer's stock nearly doubling over the past three months -- up almost 50% in the last few weeks since Charney's ouster -- it could have the chance to gain even more with a new slate of executives steering the ship.

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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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