GNC Holdings Inc (NYSE:GNC) is coming off a catastrophic 2017. GNC stock entered the year around $12 per share and proceeded to lose 70% of its value. The company was part of the famed retail apocalypse: Mall traffic is plunging, and GNC is taking a beating because of it. The company dumped its dividend, and things continued to get worse from there. Now the sharks who are circling as short sellers declare that GNC will soon fall into bankruptcy.
But is all this talk a bit too negative? Sure, GNC stock has gotten annihilated. But the recent debt for equity swap should keep creditors off their back for awhile. And after a strong holiday season for brick-and-mortar retailers, perhaps Amazon.com, Inc. (NASDAQ:AMZN) fears will simmer down for a bit. At $3.50 per share, is the GNC stock price finally ready to recover?
Horrible Capital Allocation: GNC’s management has made some terrible missteps recently. The worst of these was with its horribly-timed share buyback. Between 2011 and 2016, the company bought back more than a third of its stock, taking the share count from 105 million down to 68 million. The prevailing GNC stock price was between $40 and $50 per share for most of this time period.
Troublingly, the company largely paid for this buyback by increasing its long-term debt by hundreds of millions of dollars over that stretch. Now the chickens have come home to roost. GNC stock has collapsed, but the debt to buy back stock at $50 per share is still on the balance sheet. GNC faces the unenviable prospect of issuing stock in the single digits to raise cash, after buying stock in the 20s as recently as last year. Management destroyed a ton of stock value with its ill-timed financial maneuvering.
Malls in Trouble: GNC has tons of locations in malls. And many are in the tier 2 and tier 3 malls that are struggling, not the tier 1 malls that have largely managed to avoid the retail meltdown. As mall enthusiasts note, even in the deadest of malls, you’ll generally still find the GNC faithfully soldiering on after almost all other national chains have pulled out.
This is a massive problem for GNC going forward. As mall traffic at lower-end malls continues to decline, GNC will see revenues continue to taper off. The company needs to come up with some new strategy — such as its efforts to grow in China — to offset the continuing decline on U.S. sales. Unfortunately for GNC stock, the company may run out of time before it can evolve its business model.
Bankruptcy in 2019? In March of 2019, GNC has a major problem. The company’s $1.1 billion term loan facility matures at this time. Given that the company’s market cap is currently under $250 million, this is a simply enormous amount of debt – more than four times the company’s remaining equity value.
Previously, the company could reasonably expect to roll over this debt. But what lender is going to extend more credit if the GNC stock price is still at $3 in 2019 and the company’s current struggles haven’t diminished? Unless conditions turn sharply for the company by then, the company will face several unpleasant options. It can (maybe) take a new loan at a punitive interest rate. It can dilute GNC stock to smithereens. Or it can go bankrupt. All of these are bad to awful outcomes for GNC stock.
With that debt maturity just 14 months away, the clock is ticking. The company already tried and failed to refinance this debt last year. The company also apparently tried to sell itself. It hired Goldman Sachs to explore strategic alternatives, but that didn’t amount to anything either. As fellow contributor Luke Lango put it, the company’s excessive leverage make GNC stock a ticking time bomb.
Debt Exchange: At this point, GNC needs to focus on keeping the lights on past March 2019. As such, the recent debt for swap equity is a positive. Yes, it has been a catastrophic destruction of value for GNC shareholders lately. But that’s all in the past.
Looking ahead, this takes around $100 million out of the debtload, a small but meaningful step toward tackling the problem. Credit rating agency Fitch gave it a thumbs up, and lifted GNC’s credit rating from RD (restricted default) back up to CCC (substantial credit risk), triggering a rally in GNC stock. GNC is far from out of the woods, but this does help.
China: GNC has made a big move overseas. While U.S. sales continue to slump, international revenues are up almost 20% year-over-year.
China is a big part of the picture. Analysts have offered a range of estimates for GNC’s value there from $100 million to as high as $500 million. What’s certain is that China is a hot market for vitamins and supplements. Companies such as Herbalife Ltd. (NYSE:HLF) have had great success in China, and GNC could follow in their footsteps. A joint venture, investment, or buyout of the Chinese unit would do a lot to validate GNC’s international efforts.
Short Squeeze Potential: Often, when a stock price declines, short sellers take their profits and move on. They haven’t done this with GNC stock though. In fact, the opposite is occurring: Short sellers are amping up their bets as GNC stock price shows ever more sickness.
As of the latest reporting period, GNC stock short interest has now topped 45% of the float. That adds up to a massive 30 million share short position. GNC’s market cap is under $250 million, and yet short sellers have a $100 million+ bet against the company. Needless to say, any sort of favorable news could send GNC stock flying.
GNC Holdings is far from dead yet. The company still has more than a year to figure out how to overcome its crippling debt load. The strong 2017 holiday retail season may open doors for struggling companies such as GNC to firm up their balance sheets.
With short interest through the roof, GNC stock could squeeze strongly on any positive news. That said, I’d only play GNC stock for a trade. The company’s core business model is under fire, and there is no guarantee it will be able to keep kicking beyond March of 2019.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.