Guitar Center is the rare retailer to be betting heavily on brick-and-mortar for its future.

At a time when overall music instrument sales have stalled and web sites like
Amazon.com AMZN 0.35% , eBay EBAY 0.23% and Craigslist are selling more and
more music gear, Guitar Center is doubling down on its physical presence, with plans to
open between 15 and 20 stores a year for the foreseeable future on top of its current
fleet of 262 locations. (It had 210 stores back in 2007.)
One such new store is the mega-store Guitar Center opened Thursday in New Yorks
Times Square.
The 28,000-square-foot location is indicative of how the privately held company has
been radically re-thinking its retail approach. The flagship, about the size of an average
Barnes & Noble, will have 9 recording studios, offer extensive music lessons and
instrumental rental programs, and boast a snazzy Platinum Club area to showcase its
most expensive guitars. And this being Times Square, with the requisite need to dazzle,
the Guitar Center flagship will permanently house Eric Claptons favorite Fender
Stratocaster, Blackie which the chain bought for $959,500 in 2004, an auction record
that still stands.
While the Times Square store is much larger than a typical Guitar Center, more and
more locations of any size in the fleet will offer the same services: currently 80 stores
have training spaces, something Guitar Center wants at all stores by 2017. Some 55
locations have recording studios now, and that number will hit 85 by year-end.
Meanwhile the company, which sells all manner of items like drums, recording software
and sheet music, in addition to guitars and amps, is ramping up rental programs at more
stores.
So the idea is for Guitar Center to make its physical stores a more appealing destination
that serves more customer needs with high-margin services that Amazon, and for that

matter, small independent stores, cant offer. This will reduce its dependence on
instrument sales and, it hopes, raises its profitability the return on investment for studio
space has been 20%, for example.
In addition to the store expansion the company has already scouted 150 potential
store locations the company wants to retrofit about 207 stores so they are configured
to also offer these services.
We really want to bring these new services to the existing storeswe have great
stores that do a lot of business but really do it with a tired format, Chief Financial
Officer Tim Martin said at a media event in New York.
Guitar Center is by far the dominant U.S. specialized musical instrument retailer, with
2013 sales of about $2.2 billion, or five times more than its closest rival, Sam Ash
Music, and a 32% share of the market, according to data from Music Trades, an
industry publication. But while Guitar Center is targeting annual sales of $3 billion by
2020, its business, like that of the overall industry, has yet to fully recover from the
2008-09 financial meltdown. And that is despite help from the disappearance of
countless independent stores and the decision by mass retailers Wal-Mart
Stores WMT 0.66% and Target TGT 1.04% to drastically scale back their instrument
assortment since then.

The companys expansion and remodeling plans are expensive and until April, it didnt
really have the money for it as it dealt with the heavy debt burden leftover from the $2.1
billion leveraged buyout by Bain Capital in 2007. That changed when private equity firm
Ares Management took a 60% stake in Guitar Center in a deal that converted some its
debt in the retailer into equity. Bain Capital still owns a stake in the retailer. Following
the Ares deal, Guitar Centers debt fell to $1.1 billion from $1.6 billion, and its annual
interest expense fell $70 million, freeing up a lot of the cash it needed.
Guitar Centers focus on its stores might seem out of step with prevailing conventional
wisdom and current practices: growth in store counts at the 100 largest U.S. retailers by
revenue has slowed to less than 3% from more than 12% three years ago, according to
new data from Moodys. And more and more people are buying instruments online
according to a National Association of Music Merchantsreport, at any given time, there
are 1 million instruments for sale on Craigslist. Whats more, according to Music Trades,
seven of the 10 fastest-growing musical instrument retailers in 2013 were internet
stores.
They are locked in a mortal combat with Amazon, Brian Majeski, editor of Music Trade
magazine, told Fortune.(Guitar Center gets about 20% of sales online thanks in part to
its ownership of the Musiciansfriend e-commerce site.)
Yet, like many retailers, from Macys (uses its stores to fill online orders) and PetSmart
(many stores offer kennel services), Guitar Center seems to have discovered that
physical stores are perhaps its best means of self defense. In its current retail
expansion, Guitar Center will try a new tack: new stores will generally be smaller,
ranging from 7,000-11,000 square-feet as opposed to the more traditional 15,000
square feet, and most new openings will be in smaller, underserved markets. And
consolidation stemming from the continued disappearance of independent stores, which
typically dont have Guitar Centers clout with vendors to negotiate better prices, will

help Guitar Center. About one-third of the companys capital budget will go to better
integrating its online business and its stores.
While the companys fortunes seem to be turning, with four straight quarters of
comparable sales growth, the fact remains overall music instrument sales are barely
growing, making it unlikely theyll return to the $8 billion or so mark they hit in 2005
anytime soon. Whats more, guitar shipments fell 0.7% last year with only higher prices
saving the day for retailers. But turning a guitar store into a full-service business is the
prescription Guitar Center is betting on to save the day and make an eventual IPO
within five years a possibility, with the full backing of its new owners, Ares.
They want to know how can we build the stores faster, how can we retrofit them faster.
Theyre pushing me for faster, not slower, Martin said of Ares.
Wahba, P. (2014) Bucking trend, Guitar Center plans big expansion, overhaul of store
fleet.

While the biggest US name in pro audio made headlines last week with uncertain
financial news, so, too, did the biggest US name in music retail.
Yes, we were so caught up watching Avid, makers of Pro Tools, Sibelius, and Media
Composer, as they were dropped from NASDAQ and delayed earnings reports once

again, we missed the latest on Guitar Center. The big box music giant may not be able
to keep up with its debt. The Wall Street Journal [paywall] reports that the retailers
largest creditor is in advanced talks with owner Bain Capital to take over the company.
(Thats the same Bain Capital made famous by former Presidential hopeful Mitt
Romney, yes.)
One element in common: both companies saw aggressive growth plans curtailed at
least partly by the economic crisis. Guitar Center ran into trouble shortly after acquisition
by Bain in 2007, growing head-first into a slowing US retail economy. Eric Garland, a
writer, consultant, and future trend analyst, has some harsh words for the music store
on his blog on the transformational economy:
I said that the debt-laden big box model was not built for the long term. I stand by my
assessment. The events are playing out to make my point for me In the mean time,
you should think about the future of local retail the kind that doesnt end up billions in
debt. It may have quite a future.
That seems a fairly black-and-white view. The question is whether the chains debt
problems owe to the big box model fundamentally, or to a growth plan unhinged from
reality.
Heres the situation. Guitar Center has amassed some US$1.6 billion in debt, much of
it stemming from Bains $2.1 billion leveraged buyout of the company in 2007,
according to the Wall Street Journal. The talks would convert that debt into ownership
by the creditor.
Note the numbers there. A large portion of the debt in Guitar Center came from the
original, highly-leveraged buyout. In other words, you may be able to draw more
conclusions about Bain from whats happened than you would about the music
instruments industry or big box retail in general.
There could be serious implications for music manufacturers, anyway, particularly the
titular guitar makers. The big box format means accumulating lots of inventory, and that
inventory means revenue for makers. Guitar Center is such a market force that it could
pass its own financial woes onto those makers, exacting leaner margins. Then again, it
was presumably doing that already.
Owinski, B. (2007) Ares wants their money, so watch as they squeeze GC by making it
leaner and meaner than ever, all at the expense of the customer. If you think doing
business with them now is hard, just wait until this comes down. Fewer sales people
that turn over even more frequently, less stock on hand, only the latest products and no
deep inventory thats what you can expect. Itll be the way it is now, only worse, if you
can imagine. And expect to see some of your favorite small manufactures either
struggle or go out of business, as GC cuts its inventory and SKUs even more. For all
those companies depending upon GC for a good chunk of their business, times are
about to get a lot tougher.

Owinski, B (2007) Once again, this is a small industry filled with creative people. Its too
small for a company to go public, roll up smaller companies, or grow to big box levels
without the customer suffering.
He also predicts, however, that the bright spot may be the return of mom-and-pop
stores. Whether that happens remains to be seen.
In fact, the irony of all of this is that Guitar Center kept adding retail even when their
sales growth wasnt keeping pace. (If that isnt a recipe for debt, I dont know what is.)
Note the contradictions in a story for National Public Radios Marketplace back in 2012:
Kirn, P. (2014), Guitar Center strums a new tune. That story sounds some positive
notes: demand for instruments is up alongside lessons. But it also observes that Guitar
Center continued its march to expansion even as online retailers gobbled up a lot of the
actual sales growth, and that other big box retailers had run into similar problems with
debt.
Kirn, P. (2014) A Guitar Maker Aims to Stay Plugged In. But if under Bain ownership
Guitar Center has mostly managed to acquire junk debt, well see if the creditor is able
to restructure the business back to health. Bain absorbed Guitar Center in 2007, so the
stock GTRC is now defunct, in case someone was trying to go on NASDAQ to trade in
either GTRC or AVID. Its worth revisiting the original acquisition of Guitar Center. As for
how this impacts people making and consuming musical instruments, I think the scale of
the implication really comes down to whether theyve found other alternatives. Those
whose fates are intertwined with Guitar Center may face tough times. But those who
dont may see this as non-news. If youre a manufacturer, wed be curious to know how
much you rely on the big box chain or its rivals.

Garland (2003) A quick summary tells the tale of how close we are to the end, but first
we should revisit the beginning. Guitar Center grew with the help of private equity firm
Weston Presidio to become a national competitor and, eventually, a publicly-traded
company. With the leadership of Marty Albertson, Larry Thomas, and others, the

company continued to grow and prosper as a public company until leaders enlisted the
help of Bain Capital to take the company private through massive leverage just prior to
the largest financial crisis in a century. As you consider any of the other events
associated with the present, this Original Sin of the past is the very root of the problem.

Private equity firms like Bain take mid-sized companies and pump them full of debt with
the express intent of making them industry-dominating competitors, selling them to the
stock market as a candidate for massive growth, and cashing in. To make this possible,
private equitys stake in the company is usually represented by payment in kind (PIK)
notes, a type of bond that pays crushing interest in this case 14.09% but requires no
cash outlay until the bonds maturity. So that 14.09% is accruing, but it isnt due for
years, ideally after the company has been sold to what is often charmingly referred to as
the dumb money, the retail investors who buy a stock without knowing the companys
true financial position. Before any of the companys real problems are revealed, the
private equity firm receives its payback in the form of stock, since PIK notes can be paid
back in any medium of exchange. If all goes to plan, the stock price shoots up after the
IPO and the PE firm makes a tidy profit all in about three to five years.

Bain made two critical mistakes from which it cannot recover. First, it attempted to run
this playbook on a company that had just done this very thing with Weston Presidio five
years prior. Second, it did so just as the housing fraud and financial insanity which
characterized the late 1990s and early 2000s nearly destroyed the U.S. dollar and left
us with martial law. Every business maneuver that follows this initial error is too little, too
late. Compound interest on debt is the strongest force in the universe, and retail has
changed too much for any predictable corporate management technique to have a
noticeable effect. The rest of this story is details.

His blog post Guitar Center and the End of Big Box Retail goes unexpectedly viral just
as GC management is negotiating with its creditors to deal with the fact that it does not
expect to be able to honor its financial covenants in the near-term. In response,
management claims that the firm is stronger than ever, that every single store is
profitable, and that the $1.6 billion in debt with short-term liabilities of over $1 billion is
manageable. The company has $25 million in cash going into the Christmas season.
The Securities and Exchange Commission begins to investigate irregularities in how GC
considers the interest on its bonds to be outside of expenses that would impact
EBITDA. Garland (2013)
The company reaches an agreement with its largest bondholder, Ares Management, to
exchange the latters PIK notes for equity. $401.8 million in PIK notes are retired in
exchange for holding company preferred stock. In a statement by Standard & Poors, the

agency expects to lower the corporate credit rating to SD which is selective default
and considered tantamount to bankruptcy because it is a distressed exchange in
which investors receive less than what they are promised. (Garland, 2012)
Bain and Ares offer the bond markets two new bonds to pay back existing bondholders,
a $615 million offering of Senior Secured notes with a coupon of 6.5% maturing in 2019,
and a $325 million offering of Senior Unsecured notes with a coupon of 9.625%
maturing in 2020. These securities are purchased by institutional investors such as
LeggMason, GoldmanSachs, and Prudential for their high-yield income funds which go
to round out the assets of pension funds, ETFs and other, more conservative portfolios.
They produce less than $50 million in free capital for Guitar Center and will still require
an all-in coupon payment of around $35 million every six months. Guitar Center press
officers attempt to portray this as a dramatic improvement of its financial situation in
what is probably the best possible example of the Yiddish word chutzpah. Moodys
and Standard & Poors assess the companys family rating as subprime and its
unsecured bonds as junk, with outlook negative. Bond covenant analyses note that the
restructuring will only produce enough free cash to pay for the interest on these
instruments- there would still be little chance that the company could make strategic
moves in the industry. This view assumes that business condition will remain the same
or improve. If they get worse, all bets are off.

August 2014: Guitar Center secures a lease in the most expense real estate on earth
Times Square, Midtown Manhattan, New York. CFO Tim Martin claims that not only will
this not be a drain on finances, they would make a lot of money. He also announces
that then-CEO Mike Pratts 2020 Vision was to achieve $3 billion in revenue in just five
years a 20% year-over-year growth in a slow-growing industry. The Times Square
Guitar Center debut was accompanied by a 36-second video from the grand opening
described as a new gateway to hell, featuring fifteen metal guitarists and three
drummers playing nonsense simultaneously. It received 500,000 views in the first 48
hours.
November 2014: Guitar Center is forced to admit to bondholders that despite its
promises to thrive from its new capital structure, its EBIDTA has slipped 35%, same
store sales are down, and total revenue is flat. Secondary debt markets double the yield
on its bonds overnight. Investors who committed to the bond months before are willing
to take a 10-35% loss in a few short weeks rather than commit to the companys future.
CEO Mike Pratt resigns and is replaced by Darrell Webb, a retired executive whose
most recent experience is as CEO of JoAnn Fabrics and the Sports Authority, two
companies that also answer to private equity.

December 2014: Guitar Center fires Gene Joly, longtime executive and current
president of the Musicians Friend unit, two days before Christmas.

January 2015: Citing a bloated cost structure that keeps the company from achieving
historical profitability, new CEO Darrell Webb fires 42 corporate executives, including
the last remnant of Mike Pratts team, as well as 28 regional managers. Music Trades
reports that the company is down to $10 million in available cash after Christmas.

The constant, smarmy mantra of impenetrability and infallibility has finally been
dispelled. Their new executives have, at long last, ceased the comedy routine about
how Guitar Centers stores are always profitable no matter how many times Standard &
Poors declares them technically in default, or that a billion dollar of debt is totally
normal and wonderful and manageable. In a recent email, Webb explains the firings
with the dry rationale of needing to be profitable, and foreshadowed that the company
will continue to seek efficiencies. We seem to be hearing much less about that $3
billion in future revenue and much more about the jobs yet to be cut.

After all the noise, we are entering the final phase.

THIS IS THE END, MY FRIENDS

Nobody can manage this situation, much less lead the organization out of chaos. All
reports indicate that Darrell Webb is not there to save a thing he reportedly has less
knowledge of the music business than the Canadian who was just warming his chair.
You would think that if Ares Management was serious about saving this company, they
would choose a younger, more innovative executive able to lead Guitar Center into a
disruptive future, but instead they hired a man who wouldnt know a Marshall Plexi from
a nuclear submarine. I submit that Webb is the perfect choice for his likely mission: to
lead the company into an orderly bankruptcy. Should the company achieve Chapter 11
reorganization instead of the final, fatal Chapter 7 liquidation, it must be on good terms
with vendors and bondholders. They can lie to employees all they want, but accounts
must be in order if there is to be value salvaged from this doomed structure. Thus, the
new CEO has been chosen based on a cold-blooded ability to shuffle the books for
private equity financiers, not for his ability to lead a musical instrument organization into
a disruptive future.

I have already read analyses of Webbs recruitment as a way for Ares to get somebody
more capable of achieving their vision. This is a mass hallucination that stems from
the old PR teams attempt to recast the financial failure of 2014 as the addition of a
smart, valuable partner with expertise in retail based on that companys recent takeover
of Neiman Marcus alongside their partners, the Canada Pension Plan Investment

Board. Commenters in the musical instrument industry seem to understand little about
Ares Management, a very large, serious firm that has, since taking equity in Guitar
Center, gone public and engaged in a strategy that would put it more in the category of
the JP MorganChases and GoldmanSachs of the world. There has not been a single
public comment from an Ares employee since 2014 about the future vision for Guitar
Center and I suspect that one does not exist. Go look through Ares quarterly reports
and press releases and search for the word guitar. Perhaps that will provide a
perspective on the relative importance of this transaction to a company with a much
larger financial play in the works.

This is pure speculation, but given the size of their investment I imagine they see Guitar
Center as a deal they made back in the mid-2000s before the crisis, one that Bain
screwed up. They probably took the equity as the best way to perhaps get something
instead of pennies on the dollar. These days, theyre more busy reopening factories in
Europe along with national partners. They have better things to worry about than this
sad scene, but this is a conclusion that will be very uncomfortable for members of the
musical instrument industry who will not want to feel quite so unimportant.

The fact is, the die is cast. In a couple of weeks, Guitar Center will need to report its
Christmas performance to its bondholders. If things do not look good, its bonds will be
ripped apart like Radio Shacks. Moreover, if I had to guess, the $10 million in Guitar
Centers coffers will not be enough to make the payment to their bondholders due in
April 2015. In advance of that, they will need to seek protection under Chapter 11 of the
bankruptcy code. Maybe they have another ultra-complex trick to bring out of the private
equity playbook, but this whole thing is a waste of time. None of this sells guitars or
inspires kids to be better musicians in a world where laptops play the tunes. Were all
analyzing the most mundane details of the terminal symptoms of this sickness that has
seized American business culture in the past twenty years. Perhaps we need to heal
that disease before we can back to fun things such as playing guitar and running
profitable companies.

Heres what this really means: its the end of big box retail, an irrational addiction to
growth, and the scourge of unregulated structured finance. For a few years, unwise
urban planning and unregulated banks created a new bubble in the American suburbs.
People bought homes they could not afford and turned their houses into lines of credit.
This swindle eventually brought the economy to its knees and has taken most a decade
to regain some state of uneasy equilibrium. Still, it was particularly stimulating to a
certain type of retail that also depended on constant growth and financial trickery. The
objective truth is that the growth of the last decade was financed by banking fraud, and
that financial trickery of this sort only fools people in the short-term. Eventually, you

must have a product people demand, sold by competent people who care about the
business, financed in a way that makes sense.

This unforgiving reality will work great for local stores and entrepreneurs with a classic,
cautious approach to business management. For a while, suspending our disbelief in
reality allowed standard-issue corporate financiers to run a pump-and-dump scheme on
all kinds of retail, selling risky ventures to dumb money and reaping the rewards for a
select few. We are all wiser now, and the market conditions simply will not support that
behavior.

This is not a moral judgment, merely an assessment of market engineering. Small and
smart will carry the future while big, dumb, complex, and dishonest will bite the dust.

These conclusions were my instincts before I conducted research into the example of
Guitar Center. I was reasonably sure then, and I am entirely convinced now. The only
remaining question is where the industry will go from here. Go ask the good people at
Behringer for a preview. Representatives from their company have informed me that
since they parted ways with Guitar Center they discovered a network of smaller, more
focused retailers who were more than excited to form a stronger relationship with their
company, and in turn delight customers even more. This resulted in the companys
greatest annual revenue in history, both in the United States and throughout the world.
Behringer seems to think that a world without a single, corporate, banker-driven industry
hegemon is not only possible, its preferable.

Thats a bright future, if you choose to share that vision. But whether you believe in it or
not, this scenario is unavoidable. Guitar Center is finished. Now the musical instrument
industry can get back to business.