- Trading

We are analyzing a special situation with American Apparel ($APP). As background, $APP secured rescue capital from Michael Serruya and Delavaco Capital on April 26 to help $APP avoid filing for bankruptcy. The company was able to re-negotiate the terms of their debt to avoid default provisions triggered when 2010 financial statements contained a “going concern” clause. At that time we initiated a very small long position in the stock, and we have been monitoring the situation ever since.

We think $APP offers a good risk/reward profile, with high risk but higher reward potential. It gets even better if the final deal goes through.

Today $APP announced plans to replace 2 of their directors. We think this is good news for the stock, and we added to our small position. Here are the main points:

● Serruya and Delavaco Capital bought 15.8mm shares at $0.90 per share. They have the option to buy another 27.4mm shares at $0.90 within 6 months of the initial investment [October 26]

● As part of the terms of the investment, the CEO of the company has an anti-dilution provision. If $APP reaches stock price performance goals of $3.25 by 2013, $4.25by 2014, and $5.25 by 2015, the CEO receives a total of 39.7mm additional shares. The likelihood of trading at these levels is elevated.

● The company’s 2010 sales were $533mm. Costs are high in both Cost of Goods and Selling / General & Administrative costs, but with some cost-cutting measures the company may be able to return to profitability.

● Total debt is well-collateralized:

Long-Term Debt as of Year End 2010: Total $139mm
Revolving Credit Facility at Bank of America, $75mm, $53.4mm is drawn, due July 2012
Term Loan at Lion, $81.2mm matures Dec 31, 2013

Assets as Collateral for Debt (as of Year End 2010): Total $287.3mm
Cash $7.6mm
Accounts Receivable $16.7mm
Inventory $178mm
Property and Equipment $85mm

● The company may now have enough time to return to profitability before cash runs out. The current rescue investment is for $15mm immediately plus an additional $25mm over the next 6 months at the discretion of the investor, for a total potential cash infusion of $40mm this year. Total cash usage for operating activities was $32mm in 2010, although it should be noted that in 2010 the company reduced inventory by $37mm (20%).

● The company is scheduled to announce earnings on August 1.

● All bets are off if the final tranche of the deal does not go through.

Written by Jennifer Galperin. Follow me on Twitter and StockTwits.

Update on Thursday, July 7, 2011 at 12:32PM by

Michael Bigger

Today APP announced sales numbers for the quarter ended June. Sales were flat relative to last year’s June quarter, $132mm, despite a decrease in the number of stores. We think this is very positive for the company. Wholesale sales were down 4%, with the implication that retail / online sales made up the deficit. We think this is a positive for operating margins. We think of this company as a potential turnaround story, and today’s news represents confirmation that numbers are starting to turn around. The earnings report is scheduled for August 1.