American Apparel's (NYSEMKT:APP) firing of idiosyncratic founder and CEO Dov Charney for some undisclosed transgression was dramatic enough, but chaos now reigns at the edgy apparel retailer, and that may be more than some investors are willing to risk. A second major shareholder has now thrown up its hands and liquidated its entire position in American Apparel, indicating that substantial doubt exists about the company's future even as a hedge fund throws it a lifeline.
In a filing with the SEC on Tuesday, 1832 Asset Management revealed that it sold its full holding of 11.5 million shares of American Apparel stock, a total amounting to some 6.6% of the retailer's outstanding stock. That came after Five T Capital, American Apparel's largest outside shareholder, disposed of 79% of its holdings at the end of June. It had only acquired the position in April, buying 22 million shares, or 12.7% of the stock available, when the retailer was raising funds earlier in the year.
At the time Five T thought the clothing company's future looked bright and saw no reason to agitate for any change, but the big changes that unfolded just two months later were apparently too much to stomach. It reduced its position to 5.5 million shares, or just 3% of the total. It's still bullish on American Apparel, but with so many outcomes in play at the moment, Five T needed to reduce risk.
That's a polite way of saying that Five T has no idea what the heck is going on, and apparently neither does American Apparel. Even as 1832 Asset Management was dumping its stake in the retailer, the company was filing statements with the SEC saying that although it had fired Charney, he's still the CEO.
That seemingly bizarre statement was necessitated by Lion Capital demanding repayment of the full remaining $10 million balance on its loan to the company. The loan had a "key man" provision giving the hedge fund the right to call in the debt if the CEO was let go.
American Apparel's position, however, is based on a 30-day "cure" period in Charney's contract, which theoretically gives him a month to rectify whatever problem remains outstanding. So where Lion Capital says the triggering event occurred on June 18 when the retailer announced the ouster, American Apparel says that can't occur until the cure period ends on July 19.
The point is critical because if the retailer defaults on Lion's debt, then its line of credit with Capital One Financial will also go into default. And since Lion has asserted an "invalid acceleration" of the debt, American Apparel claims, the retailer is reserving its right to damages against Lion for calling in the loan.
Even with all that going on, American Apparel says it has the funds to pay off the loan. Through another convoluted arrangement with a second hedge fund, the retailer and Charney are plotting a course that could actually end up seeing Charney reinstate himself as CEO.
Standard General arranged to buy shares in the company and loan them to Charney so he could increase his stake to almost 50%. In return, Charney turned over his voting rights to the P/E firm, giving it effective control of the company. If Charney collects more than half of American Apparel's stock, he could effectively rehire himself. Yet at the same time, the retailer just completed negotiations with Standard General to have it take over effective control of the company in exchange for a $25 million influx of cash, more than enough to pay off Lion Capital and otherwise keep the company afloat. It will also clean out the retailer's board of directors, and will keep Charney on the company payroll for the time being as a strategic consultant.
In short, as Five T Capital asserts, anything can happen. They say the market hates uncertainty, and it's clear there's no sure outcome here. When chaos reigns, keeping your risk to a minimum -- or pulling out altogether -- is the wisest choice to make.
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.