Staples' recent 1Q23 earnings performance has thrust the retailer into the spotlight as early post-COVID hopes of a full return-to-office dissipate and questions on how sponsor Sycamore Partners could address the issuer’s maturity wall come front and center, according to three sources familiar with the matter.
The office supply company's bonds, while rebounding, have continued to trade lower on the back of its 1Q23 earnings in mid-June. In the quarterly report, Staples highlighted a 2.4% year-over-year improvement in revenue to roughly USD 2.676bn and 11.8% YoY EBITDA growth to USD 209m, but the gains were overshadowed by fears that top- and bottom-line growth might be plateauing going into subsequent quarters, the sources said.
During the earnings call, management reported that sales in May started off steady but trickled off toward the end of the month and were flat in June, one of the sources noted. “Some investors interpreted that to mean that sales and EBITDA was leveling off and the return-to-office growth is slowing,” the source continued.
Return-to-office is a major driving factor for Staples since the company enjoys higher margins from B2B sales delivered to offices over shipping products to workers’ homes, the first source noted.
“Workers are unlikely to return to the office full-time in the near-term and the recovery in occupancy rates in major metropolitan areas in New York, San Francisco and Chicago are still lagging pre-COVID levels significantly," the same source went on. "However, workers are coming back on a more consistent basis and on average for three days in a week as management has said in previous calls. This is driving the uptick in usage of office supplies with higher margins such as paper and toner."
A third source familiar noted, though, that management’s focus on part-time return to the office marks a concession from past claims that workers could return five days a week.
Adding to investor angst, the company has so far remained tight-lipped about its plans to address its upcoming maturity wall – which totals more than USD 5bn through 2027 – stoking fear among skittish investors that Sycamore could pursue an aggressive liability management exercise to the detriment of creditors.
The issuer has adequate liquidity – a total of approximately USD 760m for the quarter ended 29 April split between USD 148m of cash and USD 612m of revolver availability – to address the USD 300m TLB due September 2024, the sources agreed.
Staples could also follow the trend of other issuers and look to amend-and-extend the 2024 term loan to align with the 2026 maturity on the USD 2bn TLB, two of the sources said. The move would buy Staples more time to generate higher sales and margins, the first source added.
The looming worry for investors, however, is that Sycamore pursues aggressive tactics to handle the maturities given the financial sponsor’s track record of executing deals that have led to litigation and claims of fraudulent maneuvers from creditors.
In one example, Sycamore spun out plus-size clothing retailer Torrid from Hot Topic in 2015, removing it from the guarantor package. In 2017, a group of bondholders sued, accusing Sycamore of selling Torrid to its affiliates for a below-market rate and of violating the indenture. The parties eventually settled and Torrid was returned to the credit package.
In another notable case regarding Nine West, the retailer ended up filing for bankruptcy in 2018 following Sycamore’s LBO in 2014. The UCC accused the firm of carving out three valuable segments and selling the assets to its affiliates below their true value. The drawn-out fight ultimately ended with unsecured lenders recovering 91.5% of the new equity and Nine West’s exit financing containing lender friendly protections that bar the company from moving IP into unrestricted subsidiaries.
For Staples, creditors worry that loose documents could provide an opening for Sycamore to layer existing debt or execute a J Crew-style deal, the third source said. The second source, though, said any worry appears premature given the sponsor doesn’t have an immediate need to take action.
Also of note, the sponsor has already cashed out a majority of its investment in Staples since acquiring it in 2017. Sycamore extracted a USD 1bn dividend from the company in 2019 in a challenging refinancing that required the sponsor to purchase some of the unsecured notes issued to fund the payout and agree to tighten the covenant package.
Amid Staples' looming refinancing fears, there is cautious optimism that the company will continue to generate cash, said the first two sources.
For FY23 ending in January 2024, estimates call for the retailer to bring in around USD 100m of free cash flow, based on projections of USD 250m in cash from operations less USD 150m in capex, the sources said. EBITDA is expected to come in at roughly USD 900m, the first source added.
The EBITDA projection marks a continued recovery for Staples since the start of the pandemic. The issuer generated around USD 835m in EBITDA for FY22 and USD 690m in FY21. However, expectations don't peg Staples continuing to rapidly grow moving forward, with projections calling for low single digit revenue growth to the company effectively plateauing at current levels, the sources said.
The outlook also lags Staples' pre-COVID earnings in FY19, when the borrower booked more than USD 1bn of adjusted EBITDA, as reported.
Moreover, the company’s debt service costs have been steadily increasing as its floating rate TLBs and ABL have remained unhedged since Sycamore took over the company, the first source noted. For FY23, Staples' interest expense could climb to up to USD 550m, the source said. This compares to USD 442m in interest expense reported in FY22 and USD 388m reported in FY21, the source continued.
Staples generates enough EBITDA to cover its interest expense, but not enough to materially reduce leverage, the second source added.
The USD 1bn 10.75% senior unsecured notes due 2027 traded down to the mid-50s in the week after 1Q results from trades at 63.75 on 15 June, according to MarketAxess. It has since recovered to last trade at 60.75 on 13 July. Its USD 2bn 7.5% senior secured notes due 2026 similarly traded down in the days following the 1Q results release, dipping to a low of 79.5 on 22 July, from 84 on 15 June. The bond has since recovered to trade at 83.75 as of yesterday (13 July).
The borrower's USD 2bn Libor+ 500bps term loan due 2026 was last quoted 86.125/87.284, roughly the same level as prior to the release of first quarter earnings. The USD 300m L+ 450bps term loan due 2024 is quoted 98.79/99.7.
Staples did not respond to a request for comment. Sycamore declined comment.