Bain-backed TOMS Shoes, a pioneer in social-good retail, downgraded at Moody’s

Moody’s Investors Service downgraded TOMS Shoes, a footwear company backed by Bain Capital, citing excessive leverage in a challenging retail climate.

The agency assigned TOMS and its first-lien term loan a rating of Caa3, the lowest for “bonds of poor standing,” based on weak earnings.

The company’s slightly better probability-of-default rating of Caa2-PD was affirmed, buttressed by $18 million of interim liquidity provided by shareholders in Q3 2017. The outlook was changed from stable to negative.

Founded in 2006 by Blake Mycoskie, TOMS came to prominence with its pledge to donate one free pair of shoes for each one sold, a philanthropic ethos that remains an asset for the brand, according to Moody’s.

Bain purchased 50 percent of TOMS in 2014, in a deal that valued the company at $625 million. A $300 million term loan, balance-sheet cash and $169 million of new cash equity from the firm were used to finance the transaction, refinance TOMS’ existing debt and pay a cash dividend to Mycoskie, with Bain receiving voting control.

At the time of the LBO, Moody’s gave TOMS a rating of B2, indicating high credit risk. That evaluation reflected the company’s “very narrow product offering and small size in terms of revenue,” the agency said.

At the time, Moody’s expected TOMS’ debt-to-EBITDA multiple to remain at or near 4.5x, and said “a higher rating is possible if TOMS achieves substantially greater product diversity and a significantly higher degree of revenue and earnings stability.”

As of Q3 2017, TOMS’s management-adjusted debt/EBITDA was 9.3x, and the figure was significantly higher by Moody’s reckoning — above 15x, “as our calculations do not include significant add-backs for items the company views as one-time.”

Although TOMS also sells sunglasses, handbags and coffee, about 96 percent of its sales come from footwear, Moody’s noted, and the centrality of its signature alpargata canvas shoe presents “very high fashion risk.” In the agency’s view, TOMS has yet to recover from an earnings decline in 2015, driven by a decrease in sales of that product, against the backdrop of the broader retail downturn.

A strong e-commerce presence represents a bright spot. But given headwinds in the sector, whether TOMS can execute a turnaround and get leverage closer to 6x is uncertain.

The company has made “significant progress in its business transformation efforts” since Bain came on board, Moody’s said, including investment in sales and marketing, diversification of footwear offerings and increased sourcing efficiency.

Gross profit was up in Q3 2017, and costs have been cut by around $15 million. But the agency expects “the ongoing weakness in the apparel retail sector to offset much of the benefit of these initiatives.”

A spokesperson for Bain Capital declined to comment.

Action Item: Check out Moody’s rating action report on TOMS Shoes here.

TOMS Shoes founder Blake Mycoskie prepares to start the second round of the Pebble Beach National Pro-Am golf tournament at the Monterey Peninsula Country Club in Pebble Beach, California, on Feb. 7, 2014. REUTERS/Michael Fiala