Credit Squeeze Has a Choke Hold on Catalogers

You may be finding it tougher than ever to obtain credit. Or perhaps your bank has even called in its loan to you. If so, here’s a very small consolation: You’re not the only cataloger suffering from the credit squeeze.

Numerous catalogers and investment bankers agree: Lenders are becoming tightwads. “Even the strongest companies right now in our industry are having a difficult time raising capital for growth initiatives at favorable terms and conditions,” says Craig Battle, managing director of Princeton, NJ-based investment bank Tucker Capital. “That doesn’t bode well for small and medium-size companies.”

If this trend continues, the next 12 months could see a significant rise in the number of catalogers going out of business or being forced to sell their companies.

How bad is it?

Several sources in the industry note that many bankers are now reluctant to extend a loan to a catalog business even with a 100% personal guarantee (promising personal assets as collateral) by the catalog’s proprietor.

“Asset-based lenders will loan you less against inventory than in the past,” says Larry West, president of New York-based investment bank West Cos. “Whether it’s deal financing or growth financing, the marketplace is as tight as we’ve seen.”

Tucker Capital’s Battle knows of one company, a $30 million-$40 million cataloger, that was recently turned down by a bank with which it had a longstanding relationship. Like many businesses, this cataloger has a peak period. To prepare for that season, the cataloger used to borrow $10 million over its $15 million line of credit. “But the bank refused to do it in this case because of its concern about the company’s, the industry’s, and the economy’s softening results,” Battle explains. “That left the company unable to execute its circulation strategy and put it at some risk.”

Not only are lenders less willing to make loans, but the loans they are making are generally for smaller amounts. “Unsecured lenders would typically lend about 3.5 times cash flow or EBITDA [earnings before interest, taxes, depreciation, and amortization]. But that’s dropped to 2.5 times,” Battle says.

West cites the example of a cataloger that had been working with the same lender for 11 years. This year, when the cataloger went to the lender to discuss financing, “he was told that while they’d loan him money for his growth plan, it would be only about 70% of what he wanted and thought he’d justified,” West says. “The lender gave him no rationale, just said that it was a matter of what they’re willing to do in these times.”

“These times” are as tough for lenders as they are for lendees. The weakened economy and the bursting of the dot-com bubble are causing loan defaults to soar. Moody’s Investors Service, a global credit rating, research, and risk analysis firm, expects the number of defaults to rise 50% during the next year, from the current 6% to 9.1% — frighteningly close to 1991’s peak default rate of 10.3%.

For certain, catalogs aren’t the only businesses being choked by the credit squeeze. But mailers are being especially hard hit in part because financiers mistrust intangible assets. And one of a cataloger’s key assets, its house file, is of course intangible.

“To a bank, a cataloger’s customer list doesn’t mean anything, even though it’s one of the most valuable parts of a catalog business,” says catalog industry veteran Tom Shinick, the former president of Melville, NY-based vitamins cataloger Bronson Laboratories, part of Twinlab Corp.

“Lenders are more comfortable financing assets that more easily understood,” agrees Chris Bradley, president of $21 million Portland, ME-based bedding and home decor cataloger Cuddledown of Maine.

Cutting their losses

Lenders are becoming less patient with companies, particularly those with annual sales of less than $20 million, that don’t meet their bank covenants — the performance benchmarks or guarantees that are part of a loan’s terms. “Small catalogers now see the possibility of their personal guarantees being called if they miss their covenants,” says Coy Clement, president of East Greenwich, RI-based catalog consultancy ClementDirect. “And if the past holiday was weak for them, many already have had them called.”

And once your gurantee is called in, you have less capital to finance a recovery. “Getting next year’s working capital will require another guarantee,” Clement says. “But if you write a check for $500,000 this year, can you issue a guarantee for next year? And where will your salary come from if profits are under pressure?”

So begins a downward cycle that can be impossible to reverse. “Maybe you don’t prospect as much next year, or you purchase lower levels of inventory,” says Ted Pamperin, chairman of Summit, NJ-based catalog consultancy American Catalog Partnerships. Constricting the business in this way makes it all but impossible to grow.

Seeking options

Catalogers in need of credit who have already tapped their “angel” investors — family and friends — have limited options. David Landau, a general partner with New York-based Patricof & Co. Ventures, points to equity firms, such as his own company, “who understand and appreciate that the catalog business, if run very well, can be an attractive area for investment.”

Of course, to attract the attention of an equity firm, a cataloger must be “solid and profitable with great management and attractive growth potential,” Landau says. Those criteria may eliminate a number of the smallest or newest players most in need of financing. What’s more, Landau admits that there is only “a small handful” of such equity firms out there.

Some, like Jack Rosenfeld, president/CEO of Medfield, MA-based multititle mailer Potpourri Collection, expect the credit crunch to lead to a rise in consolidation. “Smaller catalogers may opt for a larger cataloger to assume the debt, leaving the small guy to concentrate on the business,” he says. “The larger cataloger has economies of scale and, chances are, a solid relationship with a lender.”

An alternative to an outright sale is what Battle describes as “a sale in disguise.” A larger company may buy a significant stake in the smaller cataloger with the understanding that the latter has to meet certain goals within a specific time frame. If the cataloger does meet the goals, it has to pay back the larger company for its investment. If it does meet the goals, the larger company will take majority control of the business. “The balance of the shares not purchased would be bought in time,” Battle says, “in multiples of EBIDTA, so the entrepreneur would have an upside.”

Of course, the depressed valuations and the overall weakened economy could force small catalogers to sell their companies for less than they’d invested in them. And since the economy is hurting larger companies as well, there may be fewer of them looking to invest in small catalogers. That’s why some in the industry expect to see fewer catalogs in the mail this coming holiday season.

“It is likely that a number of small catalogers will simply stop mailing unless the economy picks up rather quickly,” Clement says. “And if the holiday season is weak, it would certainly cause a wave of closings.”

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