Why Businesses go Bankrupt: Reader’s Digest

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Even before private equity firm Ripplewood Holdings loaded Reader’s Digest with untenable levels of debt, the company had grown over-reliant on direct marketing of books, music and video to its vast subscriber list, where it ran into fierce competition from Amazon and others.   Whatever new ownership structure emerges from the current bankruptcy proceedings, the key challenge for Reader’s Digest will remain how to manage its flagship publication for continuing profitability while the internet continues to sap away readers and advertisers.

Lesson learned: Focus on keeping your core business profitable and healthy.

Why Businesses go Bankrupt: RedEnvelope

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Internet gift merchant RedEnvelope suffered a net loss of $4.3 million in the last quarter of 2Edit007, citing “smaller average orders, lower profit margins and a 20 percent reduction in orders shipped.”   After losing its line of credit with Wells Fargo in April 2008, the company said it had “insufficient funds to continue operations” and filed for chapter 11 in April, 2008.

Lesson learned: Try to arrange multiple lines of credit to increase the chances of getting through an economic downturn.

Why Businesses go Bankrupt: Six Flags

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At the one year anniversary of the bankruptcy of Lehman Brothers, we are naturally seeing a lot of reprise coverage as this was the largest business failure in U.S. history and by many accounts, made the U.S. financial crisis much worse.   With all of the focus on Lehman Brothers, many other recent bankruptcies have gone under reported by the financial press, which gives us a chance to turn our attention to these other companies, and ask, how did they go wrong?

Washington Redskins owner Dan Snyder invested a reported $34 million in Six Flags, the amusement park company, and took management control in 2005, bringing in a new CEO, Mark Shapiro.  However, despite closing  ten under-performing parks, and cutting costs, he ultimately was not able to overcome the heavy debt load he inherited from the prior management team.  The recession and lower park visitation pushed Six Flags into Chapter 11 in June 2009.  The equity holders will be wiped out, as the creditors, including Citigroup and Barclays take control.

CEO Mark Shapiro, in an attempt to reassure would-be customers, described the bankruptcy as “strictly a financial restructuring of our debt.”   Trip to Six Flags anyone?

Lesson learned: Be cautious about investing in a debt-laden company, in a capital intense industry; there may not be enough capital to go around.

Financial Bail-Out News Quiz

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It’s been a momentous two weeks of business news, leading to the Federal Bail-Out bill being signed into law yesterday, October 3, 2008. How many of the following news quiz questions can you answer correctly?

1. How much is provided for in the Federal Bail-out bill?
a. $7 billion
b. $70 billion
c. $700 billion
d. $7 trillion

2. What department of government will have primary responsibility for administering the bailout?
a. Treasury
b. Interior
c. Federal Reserve
d. Homeland Security

3. What did the stock market (i.e., Dow Jones index) do the day that the bailout bill was signed into law?
a. Up 778 points
b. Down 778 points
c. Up 157 points
d. Down 157 points

4. What unfavorable economic news was reported the same day as the bail-out bill was signed into law?
a. Record U.S. trade deficit
b. Oil prices back up to $120/bbl
c. Very unfavorable jobs report
d. U.S. economy officially in recession

5. Which financial institution was not offered a Federal bail-out in time to avert its bankruptcy?
a. Freddie Mac
b. Fannie Mae
c. Lehman Brothers
d. AIG

6. Which politician made a speech in March of this year “tracing the sub-prime crisis to lax oversight, and calling for a major overhaul of regulatory policy?”
a. George W. Bush
b. Barack Obama
c. John McCain
d. Michael Bloomberg

7. What led General Electric to sell $3 billion of convertible, 10% preferred stock to Warren Buffet?

8. What accounting provision, in conjunction with the sub-prime crisis, has led to weaker bank balance sheets?
a. Accounts receivable aging
b. Accelerated depreciation
c. Pooling of interest
d. Mark to Market

9. Which perk was not rolled into the bail-out bill that Congress eventually approved?
a. Extended mortgage forgiveness for homeowners
b. New/extended tax credits to promote reduced energy
c. Increased tax credits for real estate developers
d. Middle-class protection from alternative minimum tax


10. For each of the acquired, or to-be-acquired banks (a, b, c, d), match it to an acquiror, choosing from 1, 2, 3, or 4. (This one is tricky!)

a. Merrill Lynch
b. Washington Mutual
c. Countrywide Financial
d. Wachovia

1. Citigroup
2. Wells Fargo
3. Bank of America
4. J. P. Morgan Chase

Congratulations to Drew Keeling, of Kusnacht, Switzerland, for being the first to get back to me with correct answers to all 10 questions:

1. c
2. a
3. d
4. c
5. c
6. b
7. to strengthen its balance sheet
8. d
9. c
10. 2d, 3a, 3c, 4b

Rare Glimpse at Linens ‘n Things Financials

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Linens ‘n Things provided an unexpected public posting of its financial results under private equity firm Apollo Management when it recently posted its 10-k report for 2007 in conjunction with the desire of some of its private shareholders to sell shares on the NYSE. Linens ‘n Things posted a $242 million net loss in 2007 on revenue of $2.8 billion. The company had a $36 million net profit in 2005 on revenue of $2.7 billion in 2005, the last full year of public ownership (Apollo Management took the company private in February, 2006.) Linens ‘n Things gross profit margin slipped from 40.8% to 37.5% over the two year period; Selling, General & Administrative Expense increased from 38.5% to 43.7% of revenue; and interest expense increased from 0.2% to 3.9% of revenue. By comparison, publicly-owned segment leader Bed, Bath & Beyond has 2007 gross profit margin of 41.6%; Selling, General & Administrative Expense at 30.4% of revenue; and no interest expense. The Linens ‘n Things 3/20/2008 10-k report lists numerous risks, including the following: “despite current indebtedness levels the Company and its subsidiaries may still be able to incur substantially more indebtedness. This could further exacerbate the risks associated with its substantial leverage.” On April 15th, Linens ‘n Things announced that it had decided to defer $16 million quarterly interest payments due to the holders of its senior secured floating rate notes.