Gap Inc. late Thursday announced the offer of new senior secured notes totaling nearly $2.3 billion, according to a company press release. The new debt, expected to close by May 7, is backed by real estate and intellectual property.
Moody's and S&P Global both downgraded Gap following the move. S&P lowered Gap's ratings to BB- from BB while Moody's downgraded Gap's corporate family rating to Ba2 from Ba1.
The agencies reiterated their negative outlooks, both citing the pandemic. S&P said Gap will be under pressure "amid much uncertainty regarding how long operations will be disrupted and when consumer spending will reaccelerate." Moody's noted Gap's need to manage costs and cash burn "in the face of the unprecedented disruption of COVID-19."
With this announcement, Gap Inc. is following through on plans that the retailer hinted at earlier the same day in a filing with the Securities and Exchange Commission, when it said it would likely need to take on more debt in order to carry on its business and pay down existing debt.
The retailer said it will use the net proceeds from the new notes to refinance debt as well as to pay fees and expenses from the offering and "for general corporate purposes." The new debt issue includes $500 million in three-year notes, $750 million in five-year notes and $1 billion in seven-year notes.
In addition to the further borrowing, Gap Inc., like other retailers, said last Thursday that it's easing some financial pressure by withholding April rent on closed stores. Unlike most other retailers, the company said that some of those stores will never reopen, if the lease negotiations it's undertaking, in part to lower rent obligations, don't pan out.
The company has some things in its favor, according to Moody's Senior Credit Officer Christina Boni, who noted "a solid market position in the specialty apparel market" thanks to its Old Navy, Gap and Banana Republic brands. Plus, the relatively short term of its store leases (about five years) "has enabled right sizing of its mature brands (Gap and Banana Republic) while adding stores to its higher growth concepts (Old Navy and Athleta)," she said.
Investments in e-commerce "have also strengthened its operational profile and improved customer experience," she added, which will help offset sales lost to closed stores. "Nonetheless, the company will suffer significant disruption in the face of COVID-19 which will reduce its free cash flow significantly."
S&P analysts Declan Gargan and Helena Song also pointed to that strength, noting that digital brings 25% of Gap Inc.'s sales, which could rise as "recent events will likely accelerate long-term consumer adoption of online shopping."
But that will be limited by broader weakness in the economy, and its benefits undermined by the "heavy discounting" that will likely be necessitated by inventory pileups and stiff competition, they also warned.