Handleman Co. distributes music CDs. That's akin to peddling fax machines, videocassette recorders or floppy disks. They may still exist, but technology and consumer habits are passing them by. Economic activity centered on compact disc wholesaling -- marked by low margins and fast-declining sales -- makes any company a candidate for the endangered list, even one like Handleman, with more than $1.3 billion in revenue and Wal-Mart Stores Inc. as a customer.
In March, the unprofitable Handleman announced that creditors had thrown it a very short lifeline, essentially giving the company until the end of May to get its affairs in order. It sounded like time for the Troy, Mich.-based company to check into the business equivalent of hospice, and investors reacted appropriately. By late March, shares were down as low as 18 cents each; three years back, it had been in the $20 range. Some predicted it was only weeks before Handleman called it quits and filed for bankruptcy.
That hasn't happened. Instead, Handleman is undergoing a corporate version of "The Incredible Shrinking Man." It's an orderly liquidation that bypasses the courts. Investors have since pushed shares up to a walloping $1.50.
Handleman's approach is likely to become more and more commonplace, even among some terminally ill concerns. There's an obvious benefit: Creditors get a more immediate payout. The company may disappear into oblivion, but its investors stand a reasonable chance of making a little cash at the end.
Earlier this month, Handleman revealed it was scuttling its North American music business completely, selling inventory and fixtures to a private group called Anderson Merchandisers LP. The sales price amounts to a maximum of about $30.3 million, most of that stock on hand and sold at or near cost. Put another way, privately held Anderson will get the Wal-Mart business and several hundred thousand CDs. Handleman essentially gets nothing for its business but does get to retire some debt and not have to worry about how many Wal-Mart shoppers will actually pay to hear Scarlett Johansson attempting to sing. Creditors get some of their money back. Based on Handleman's last 10-K, the transaction means revenue will drop by at least 70%.
Most obviously, this fire sale reflects the state of recorded music. CD sales continue to plummet. Nobody predicts a leveling out anytime soon, especially as the generation of listeners under the age of 25 has completely forsaken store-bought music. "You don't exit a business that has upside potential," says Jerry Del Colliano. A professor of music industry and recording arts at Thornton School of Music, University of Southern California, Del Colliano is one of those who believe the recorded music industry's old economic model is already dead and buried.
Powerful retailers have squeezed it as well. In May, Handleman ended the last vestiges of a once-vaunted distribution relationship with the British supermarket chain, Asda Group Ltd., a Wal-Mart subsidiary. The final items to go: greeting cards, another antiquated product line Handleman thought had potential. Sales to Asda totaled $268 million -- or 20% of all revenue -- for the fiscal year ended April 28, 2007, but were unprofitable.
So were online efforts. The company poured $7.2 million into a startup that digitally distributes music and other entertainment. It failed. The investment was written down.
Then there are the loans to Handleman, with rates that would make a credit card company proud. Under the terms of a May restructuring, Handleman had to pay 17.5% for one $40 million term loan, 14.5% for $50 million facility.
In announcing its retreat from the music business, Handleman reiterated that its video game operation, Crave Entertainment Group Inc., remains on the block. With lots of hype and expectations, Handleman acquired Crave in November 2005 for $123.5 million. Until recently, results were less than awe-inspiring. The operation, in the words of a now-former executive, was "only marginally profitable." A good chunk of the price was assumed debt, which was immediately paid off and is unlikely to be recouped. Handleman executives didn't respond to numerous requests for comment.
If Crave gets sold, almost nothing of Handleman would be left: the remains of the U.K. distribution company and a small distributor of independent music, a business description that by its very nature is doomed. Handleman's annual revenue is about to atrophy faster than Sanjaya Malakar's post-"American Idol" singing career.
Matt Miller writes about distressed investing for The Deal.