Quicksilver (ZQK) has been one of my core bearish positions for most of the last year, as I viewed the company’s ~$800mm net debt load as unsustainable in the face of interminable secular trends and poor management. I highlighted some of the problems facing the company in a couple of Seeking Alpha articles here, here, and here.
Without rehashing the entire thesis, the basic premise was that in the short term, ZQK’s financial leverage was both unsupportable – too much leverage for a company seeing EBITDA crater and negative FCF – and also poorly structured – ~85% of the debt being subordinated to a small amount of senior debt outstanding which became the only source of liquidity and yet had nothing to gain by waiving covenants. In the medium term, the viability of ZQK’s three core brands – Quicksilver, Roxy, and DC – was threatened by the myopic decision ~2yrs ago to aggressively curtail athlete sponsorship and other marketing, thereby denuding any hope of meaningful brand recovery in the competitive teen apparel space and effectively condemning ZQK to low-margin, commoditized ‘retail hell’ (my pet term).
Horrid execution and FX headwinds (ZQK has 50% of sales outside the US) only added to the company’s woes, and ZQK filed for bankruptcy in the US today. While the company did not detail the immediate cause, I suspect an imminent covenant breach on its senior lending facility (which had minimum availability covenants threatened by ongoing cash burn, no other liquidity, and a shrinking borrowing base as the asset base shrank) was probably likely, as I had speculated last earnings report that best case, ZQK probably only had enough cash for a couple more quarters; ZQK likely tried to negotiate a waiver but since senior lenders had nothing to gain by extending more credit (given their tiny piece of the outstanding debt), it seems likely they simply refused to waive covenants and effectively tipped the company (super senior bank lenders will be made whole as a result). The various debt pieces reflect this reality: senior secured EUR and USD paper trade at the relatively lofty levels of 70-80c on the dollar, while the second lien USD bonds trade at 5c – a level that all but guarantees equity recovery will be a stone cold zero. Indeed, it is likely as well that unsecured creditors receive nothing in recovery other than a very, very small sliver of the new company’s equity (which Oaktree will control via their provision of DIP financing).
Before moving on to new business, it is worth reiterating what I believe is the main lesson of the ZQK story. Certainly, the company was caught in a maelstrom of secular forces, many of which – declining mall traffic, the rise of fast fashion, and a trough in surf and skate fashion interest among teens – appeared beyond its control. But more important, to me, were the horrible strategic decisions a succession of management teams made in the face of these challenges. Not one but two management teams chose to not pursue debt restructuring for years after it became clear the company was far too levered to effectively invest and market their product; this lesson was almost driven home (via bankruptcy) post Lehman, yet the company chose not to heed the warning the next time the business took another leg lower. Hence even when business – and the stock price – recovered, temporarily, a few years ago, there was no delevering through equity or asset sales when the chance was there. After that, ZQK made the odious choice to cut sponsorships – sacrosanct for a would-be premium athletics label – and also deracinate key staff – fatal to morale in recent years – just to maintain the debt burden, instead of, say, selling one of its core businesses or contemplating an earlier debt-for-equity exchange. This, in turn, only accelerated the vicious brand-destroying cycle, virtually guaranteeing ZQK’s fate.
Thus, if ever there was a poster child for the adage ‘you can’t cut your way to prosperity’, ZQK would be it. Hopefully the savvy new owners at Oaktree will realize this and – freed from the legacy debt burden – will rebuild the brand through investment, thereby righting recent management’s many missteps. Unfortunately, of course, this will come too late to help common shareholders – which was the core equity short thesis all along.
Disclosure: short ZQK (but not for much longer).