Investors have sharply traded down the value of $500 million in bonds that were issued by the retailer’s parent company, Chinos Intermediate Holdings A Inc. Chunks of the debt, which comes due in 2019, changed hands at 42 cents on the dollar today — down from about 64 cents a week ago, before the company disappointed with an 11 percent drop in second-quarter comparable-store sales. (The bonds trade relatively infrequently and came off a low of about 40 cents Tuesday).
Although that price movement speaks volumes about what certain debt investors think of J. Crew now — as one debt expert put it, “The market is telling you they just don’t believe in the brand anymore” — the company still has plenty of liquidity, the means to pay its bills and time to right the ship.
At least one investor struggled to understand why the debt fell so sharply and suggested now might be the time to jump in.
The company retains a fair amount of flexibility in part because the 2019 notes are payable in kind if J. Crew gets too financially stressed, meaning it could make the 7.75 percent interest payments on the debt by issuing more debt instead of paying out cash. It’s an option that gives flexibility to the company, but could disappoint bondholders wanting to be paid in cash.
Moody’s Investors Service, which on Wednesday cut its outlook on $2 billion in J. Crew debt to negative from stable, said it “believes that J. Crew has the ability to not make its May 1, 2016 PIK Toggle Note interest payment in cash, which is a feature that supports liquidity in times of stress.”
The debt watchdog said the outlook change “reflects J. Crew’s ongoing weak operating performance resulting from poor execution in a highly challenging and promotional apparel retail environment.”
But Moody’s also noted that its rating was supported by the company’s “merchandising skills as reflected by its historical track record of sales and earnings growth, credible market position in the highly fragmented specialty apparel retailing segment, very well recognized lifestyle brand names, and historically strong margins relative to peers.”
So J. Crew still gets credit for being J. Crew and for being led by chief executive officer and chairman Millard “Mickey” Drexler.
In a sense, the company finds itself in the middle of two types of investors with different immediate needs.
On one side there are bondholders who want conservative moves that will preserve their interest payments. On the other are J. Crew’s private equity owners — TPG Capital and Leonard Green & Partners — that would be more inclined to show the company has more growth ahead of it still, which would make it easier to exit the investment either by selling the retailer or via an initial public offering.
In that tug of war, TPG and Leonard Green have the upper hand and the company is seeking expansion: It is opening more outlet stores and Madewell units and recently launched the J. Crew Mercantile division.
At least some bondholders are stepping back.
“You had a lot of big, real-money investors that were still involved in the name and were hesitant to get out on the way down,” said Jenna Giannelli, a debt analyst at Citi. “The bull case has always been, ‘I believe in Mickey Drexler and I believe in the brand and I’m in for the long term.’ [Now] you’ve seen some capitulation from traditional investors.”
That could lead to more hedge funds buying into J. Crew’s debt and a more active market if the investor base switches over.
Giannelli said J. Crew’s woes stem more from missteps than from debt that was piled on when the company was taken private.
“They came with a pretty manageable capital structure and up until late ’13, early ’14, this was still an IPO story,” she said. “It was somewhat self-inflicted — the fashion decisions or angles that they took in 2014, the changes in sizing and moving away from some of their core legacy items, a lot of their basic suits…and kind of getting too edgy.”
Giannelli said J. Crew still has an “amazing design team” with Drexler and Jenna Lyons, president and executive creative director, but they still need to find a full-time finance chief and chief operating officer to round out the management team.
A spokeswoman for J. Crew declined to comment.