CreditRiskMonitor published a High Risk Report on Revlon Inc. in April, 2021, warning financial counterparties of the ongoing bankruptcy risk. A little over a year later, we have now published a Bankruptcy Case Study, as the cosmetics maker was forced to seek out court protections. This detailed report will provide five quick and important facts that illustrate the company's downward spiral and highlight some of the early warning signs you will want to look for in other struggling companies.
1. The Worst Possible FRISK® score
When we published a High Risk Report on Revlon in 2021, the company was already sitting at a FRISK® score of "1", indicating bankruptcy risk that was 10-to-50x higher than the average company. The score stayed at that worst level right up until its bankruptcy, highlighting that such downward spirals can often be more like a slow-motion train wreck than a sudden implosion. That early warning, however, allowed subscribers to take action to adjust their risk exposure well in advance of Revlon's eventual bankruptcy in June 2022.
This is the value of the FRISK® score relative to other risk metrics, like payment history. In fact, Revlon's payment history showed prompt payments all the way up to the company's bankruptcy filing. This pattern is actually quite common. The FRISK® score, meanwhile, captures 96% of all companies that go bankrupt at least three months prior to a bankruptcy filing, and 67% of them have a FRISK® score of “2” or “1.” A "red zone" score of “5” or less is the key signal that counterparties need to start paying closer attention.
2. Aggressive Moves
The problems at Revlon can be traced back all the way to 2016, when it made a bold acquisition, adding Elizabeth Arden to its collection of brands. The move required the company to absorb Elizabeth Arden's debts while refinancing its own, which materially increased leverage, and the absolute debt balance expanded by over 50%. Management expected the deal to result in higher sales and earnings. Such promises need to be monitored because sometimes deals don't work out as planned.
3. Increasing Debt Load
Elizabeth Arden didn't stumble, it was, effectively, the rest of Revlon that started to fall on hard times. To continue funding its efforts to get the business back on a stronger footing, Revlon leaned on its balance sheet. Long-term debt continued to rise, increasing each year between FY17 and FY21.
The expansion of debt was evident, but coupled with declining shareholder equity, the company's leverage rose materially over that span, with the total debt-to-assets ratio increasing from 0.93x in FY17 to 1.42x in FY21.
4. Deteriorating Performance
One of the key problems Revlon faced was a stubborn drop in its top line. Sales fell from roughly $2.7 billion in 2017 to $1.9 billion in 2020, partly reflecting the impact of the COVID pandemic. However, 2021 sales only increased modestly to nearly $2.1 billion, hinting that the problems at the company were bigger than the global health scare. Notably, Revlon lost money in each of the past five years. Worse, it was cash flow negative in each of those years, as well, which necessitated the use of debt noted above. Far from turning things around, the purchase of Elizabeth Arden appears to have been a Hail Mary pass that went awry.
The historically low interest rate environment throughout the period, however, allowed Revlon continued access to the debt markets despite its weak performance.
5. Zombie Status
One of the biggest problems, however, shows up in the cosmetics company's interest coverage, which indicated it was among the walking dead. Specifically, Revlon's interest coverage was below one in each of the past five years, indicating that it couldn't, in fact, service the debt it was carrying. The only thing saving it from bankruptcy was the largess of lenders who continued to extend the company more credit and amend the terms of their credit agreements. That became a much bigger problem in 2022 as central banks started to increase interest rates because 88% of Revlon's debt was variable rate. Too much debt, too little operating earnings and cash flow, and increasing interest costs proved too much for Revlon and it was forced to declare bankruptcy.
Bottom Line
Revlon was a slow-motion train wreck, as are many bankruptcies. However, there were ample signals of the risk if you knew where to look. The FRISK® score provided an early warning, with rising leverage and deteriorating performance proving to be notable signs of continued decline. The final nail in the coffin, however, was the company's high percentage of variable rate debt at a time when interest rates were on the rise. Although Revlon's bankruptcy story is unique, the broad themes here are common in bankruptcies. With interest rates set to keep moving higher, it is highly likely that more zombie companies like Revlon will fall soon. Contact CreditRiskMonitor today so we can help you identify the riskiest names in your portfolio.