American Apparel's Finances Are Getting Even Worse

So: What happens when a company gets delisted from a major exchange? In general, unless the delisting happens because the company’s owners want to take it private, or because of a merger or acquisition deal, delisting is considered a prelude to bankruptcy. While technically an inability to play by the rules of a stock exchange doesn’t equal an inability to pay one’s bills, equity and debt being different things, there is a relationship. Healthy companies do not, as a rule, get delisted.

American Apparel has long been in increasingly precarious financial condition. In addition to the plummeting sales, credit issues have dogged the company, which underwent an enormous, debt-fuelled retail expansion at the height of what proved to be a real estate bubble. This, coupled with poor sales, left it with serious problems servicing its loans. As Women’s Wear Daily writes, “Lion Capital helped it pay off a $51 million loan from SOF Investment in March, but just two months later American Apparel fell out of compliance with a covenant of the Lion loan covering its debt-to-EBITDA ratio.” Basically, when Lion lent American Apparel the money, American Apparel was required to hew to a standard of financial health, which it then failed to do within two months. Lion jacked up American Apparel’s interest rates to 17% in response.

Being delisted means that a given company becomes what is known as a “penny stock” — penny stocks are high risk investments that are made over exchanges with little regulatory oversight. Institutional investors understandably flee from penny stocks, credit — already a dicey proposition for American Apparel — dries up, existing loans are generally in breach (because remaining in good financial condition is a condition of those loans), and companies can become a target for shareholder lawsuits on grounds of breach of fiduciary duty.

As for those investors unlucky or unwise enough to actually hold American Apparel stock — which is trading as I publish this post at $1.35, or down 6.25% since the exchange opened this morning — The Street says:

When you own a delisted stock, cutting your losses might seem like a good move. But unless your holdings represent a large amount of money to you, it might not be worth the brokerage fees and time to sell.

American Apparel might become the kind of stock it’s not even worth the brokerage fees to trade in.

Late last month, its auditors quit after saying American Apparel had “material weaknesses in internal controls” with respect to its reporting of financial information — and that the company’s past financial reports for all of 2009 may not have been fully accurate. The new auditors are working to get the numbers for quarters one and two, while the previous auditors are still trying to check 2009’s figures. It’s not bankruptcy, yet, but it’s certainly looking pretty bad for old Dov Charney, the man who founded the largest clothing manufacturer in the United States.

I had a two-hour conversation with Charney two weeks ago — all off-the-record, at his insistence — regarding our coverage of his company’s financial state; I’ve contacted both Charney and the company spokesperson, Ryan Holiday, for a response to this latest news. I have yet to hear back.

Related:
Investor Relations [American Apparel]
American Apparel To Miss Filing Deadline [WWD]
More Financial Woes For American Apparel [AP]

American Apparel Announces NYSE Amex Acceptance Of Plan Of Compliance [MarketWatch]
What Happens When My Stock Is Delisted? [The Street]

Earlier:
American Apparel’s Bankruptcy Is Inevitable