By Dale Gardner
In an attempt to stave off the necessity of another Spalding Holdings Corp. bailout, owner Kohlberg Kravis Roberts & Co. has undertaken what analysts have long considered inevitable: a Spalding financial restructuring to reduce interest expense.
KKR, which financed its 1996 acquisition of Spalding in part with high-yield bonds, is negotiating to convert the bonds into an ownership stake, a strategy that could reduce Spalding’s debt by one-third.
In an Oct. 2 letter to customers, Spalding president and chief executive James Craigie said a successful conversion of its debt would be good news for the company, which paid $15 million in interest in the second quarter alone – money that might otherwise have been reinvested.
Craigie’s comment, though, was another way of saying Spalding’s situation is dire, with interest expenses that offset operating profits – which have actually increased this year. The company’s total debt approaches $600 million, with some $200 million of that owed to bondholders, $400 million to banks.
“Doing something now is probably good for the company,” said Nicole Delz Lynch, who tracks Spalding’s credit worthiness for Standard & Poor’s, “You need a long-term fix as opposed to a short-term fix.”
Craigie said he expected to complete the deal at least a week before an Oct. 31 expiration of a grace period on an interest payment that was due Oct. 1.
Bruce Cripe, an analyst who follows high-yield and distressed debt investments for Friedman Billings and Ramsey, an Arlington, Va.-based firm, said debt reduction is a must for Spalding.
“Eventually, they’re going to have to restructure,” Cripe said. “They’ll either have to turn some of that debt into equity, or the company will have to be sold and the proceeds will have to go to the creditors.”
KKR already has tried to sell the company, analysts said. Callaway Golf was one potential buyer, but its interest was in ball operations and patents. For a time, KKR was trying to sell other units of the company, perhaps in an effort to put a Callaway deal together. In August, KKR confirmed that its Etonic (shoes and gloves) and Dudley (softball brand) units were on the block.
With attempts to sell the company apparently going nowhere, KKR has turned to a strategy of converting debt into equity. Bondholders, earning interest at a rate of 10.375 percent, may have little choice but to acquiesce, and the company believes that if one entity owning about 60 percent of the bonds agrees to a deal, others will follow.
Refusing such a deal would increase the risk of a Spalding bankruptcy, and the first creditors in line – those with claims to its assets – would be the banks, not the bondholders. And KKR, which Cripe estimates already has invested about $300 million of its own money in the company, likely would be left with nothing if the company were to be sold or liquidated in a bankruptcy proceeding.
“There’s no value in the KKR equity,” said Cripe.
Bankruptcy, however, is not an immediate concern, Craigie said Oct. 5.
“Could I predict a scenario where that might happen? Sure,” said Craigie. “If sales fall off dramatically; if more crazy things happen around the world; if it snows from now until next July; if the bottom falls out of the economy – who’s to say? I could predict that for us or any of our competitors. Our capital structure puts us more at risk than our competitors, but we’re not in any imminent danger.”
Because of the negotiations with the bondholder, Spalding, with the consent of its largest bondholder, decided not to make an interest payment due bondholders Oct. 1, Craigie wrote in his letter. That news resulted in an immediate downgrade of the company’s credit and debt ratings by S&P.
“The real key with this company,” said S&P’s Lynch, “is KKR and how much they’re willing to invest. They’ve sort of propped it up here or there along the way. And the banks have probably been easier to work with knowing they have KKR behind them. But we’re not comfortable with the current situation. . . . If you look at the (Securities and Exchange Commission) filings, there’s a lot of very strong language in there about their ability to meet future obligations. So we’re concerned with their short-term liquidity.”
Craigie insisted in his letter to customers that an immediate liquidity crisis was not at hand, and improved second-quarter results – the strongest since the company’s August 1998 reorganization, in which it was separated from Evenflo Co. Inc. – back him up. Spalding’s net sales for the quarter were $139 million, up 8 percent from the year-earlier period. Its net income was $5.8 million, up 42 percent.
Indeed, Cripe said Craigie’s team deserves credit for improving operating results.
“I think they’ve done a pretty decent job,” said Cripe. “They got inventories down and focused on core products.”
Craigie said the decision to utilize the October grace period “has nothing to do with liquidity, as the company has adequate funds to make this payment and pay its trade creditors in the ordinary course of business. Please be assured that this issue will not impact Spalding’s ability to source, produce and ship product.”
Such assurances, however, invite competitors to use Spalding’s financial uncertainty against the company. But Craigie seems undaunted by what competitors might say or do.
“I think we’ve surprised a lot of competitors who wrote Spalding off for dead a couple of years ago,” said Craigie. “Everybody thought we’d be the road kill of the day, and we were not.”
– John Steinbreder and Dave Seanor contributed to this report