Will Michaels Debt Hurt Its IPO?

Arts and crafts retailer Michaels MIK is set to open for trading Friday and will be scraping for demand among other new issues in the busiest IPO week for a June since 2000, according to Renaissance Capital.

Michaels was taken private in 2006 by Bain Capital and Blackstone Group through a leveraged buyout. Launching its new IPO raises concerns over the company's ability to handle its excessive debt-load as Bain and Blackstone divest themselves.

As part of the offering, Michaels will pay Bain and Blackstone $14 million each to end a management services agreement.

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Michael's biggest obstacle in convincing investors to buy will be its substantial debt obligations. As of May 2014, the listed outstanding debt was $3.7 billion. According to the company, its debt load “could adversely affect our ability to raise additional capital.”

Of the $3.7 billion in debt, the company also has $1.6 billion in variable rate debt, making it susceptible to interest rate risk in the future. The interest rate risk could also “prevent us from meeting our obligations” and “limit our flexibility in operating our business.”

Based on an offering price of $18, the midpoint of its range, Michaels expects to receive net proceeds of $466 million, which will be used to pay down $466 million of an $800 million loan made in July 2013.

Michaels is making strides in its comeback, despite a heavy debt load. The company operates stores under two brand names, Michaels and Aaron Brothers. Between 2009 and 2013, the company opened 82 stores, bringing the total stores open from 1,175 to 1,257 -- a seven percent increase.

During that same time frame, Michaels was able to significantly improve its profitability from an income and a sales efficiency standpoint. Net income from 2009 to 2013 rose 135 percent from $104 million to $237 million. On the efficiency front, Michaels improved its average net sales per square foot by almost nine percent, from $201 to $218.

Michaels will price its IPO Thursday night. The company will offer 27.8 million shares between the expected range of $17 and $19. Underwriters include J.P. Morgan, Goldman Sachs, Barclays and Deutsche Bank.

Disclosure: At the time of writing, the author holds no position in the mentioned securities.