Fitch Ratings has downgraded the Long-Term Issuer Default Ratings (IDR) of Party City Holdco Inc. and its subsidiaries Party City Holdings, Inc., Anagram Holdings, LLC and Anagram International Inc. to 'CCC' from 'B-'.
The downgrade reflects the rapid deterioration in Party City's operating and liquidity profile and Fitch's belief that Party City's capital structure is likely untenable. Under Fitch's rating case assumptions, Party City will generate significant negative free cash flow in 2022, and the company has limited liquidity headroom to navigate further operational missteps. Fitch expects Party City's adjusted leverage (including rent capitalized at 8x) to exceed 10x in 2022, and could remain elevated above 8x through 2024. Party City may be challenged to address its capital structure, which substantively matures in 2025/2026, without a default unless operations meaningfully improve over the next 12-18 months.
Key Rating Drivers
Capital Structure Untenable: Under Fitch's current ratings case, Party City's adjusted leverage (including rent capitalized at 8x) could exceed 10x in 2022 and remain elevated above 8x through 2024. Party City's financial results have steadily weakened in 2022 despite a flattish topline performance, driven by meaningful margin deterioration due to supply chain challenges, rising input costs and mis-execution.
Given the likelihood that many of the cost pressures the company has faced in 2022 will persist through at least the first half of 2023, Fitch has decreased confidence that operations will improve materially before its 2025 maturities become current. As a result, Fitch believes there is an increased likelihood that the company could enter into some type of restructuring, including a distressed debt exchange, prior to its 2025 debt maturities.
Party City's EBITDA could decline to around $110 million in 2022 before improving toward $130 million in 2023, driven primarily by cost cutting and modest improvements in supply chain and input costs in the second half of the year. Considering Party City needs to generate around $150 million in EBITDA to service both its interest expense and annual capex requirements, the company's capital structure appears untenable given it will need to address upcoming maturities while likely still facing operating challenges.
Fitch recognizes that EBITDA could improve above $150 million over the next several years, but the timing and confidence in this turnaround is uncertain and the company will also need to address its 2025 and 2026 maturities before they become current liabilities.
Significant Liquidity Deterioration: Party City's liquidity deteriorated to around $120 million as of Sept. 30, 2022 compared to around $356 million at the same time in 2021. Fitch does not expect meaningful liquidity improvement over the next 12 months. Fitch expects Party City could generate negative FCF in excess of $250 million in 2022, driven both by the weak operating performance and significant inventory build. While Party City's FCF could turn modestly positive in 2023 if the company is able to unwind some of its inventory, this would also reduce the borrowing base and availability under its ABL credit facility.
Considering the company also has a $23 million notes maturity that it must fund in August 2023, the company's current liquidity profile provides limited headroom for the company to maneuver through additional operational missteps or economic volatility.
Leading Player in Party Retail Segment: Party City is a leading retailer of party goods with a global geographic footprint and good market share, in an albeit fragmented segment, in North America. Fitch believes that Party City's party goods category was increasingly disrupted by the discount and e-commerce channels after remaining defensive for years due to low average tickets, significant breadth of inventory in the category and the importance of an in-store experience.
While Fitch is not currently projecting a material U.S. recession or significant consumer slowdown in 2022 or 2023, Party City's low ticket-, event- and holiday-driven business mix may be affected if one were to occur.
Parent Subsidiary Linkage: Fitch's analysis includes a strong subsidiary/ weak parent approach between the parent, Party City Holdings and its subsidiaries Party City Holdco, Anagram Holdings, LLC and Anagram International Inc. Fitch assesses the quality of the overall linkage as high that results in an equalization of IDRs.
Derivation Summary
Party City's 'CCC' Long-Term Issuer Default Rating (IDR) reflects the rapid deterioration in Party City's operating and liquidity profile, and Fitch's belief that Party City's capital structure is likely untenable. Under Fitch's rating case assumptions, Party City will generate significant negative free cash flow in 2022, and the company has limited liquidity headroom to navigate further operational missteps.
Fitch expects Party City's adjusted leverage (including rent capitalized at 8x) to exceed 10x in 2022, and could remain elevated above 8x through 2024. Party City may be challenged to address its capital structure, which substantively matures in 2025/2026, without a default unless operations meaningfully improve over the next 12-18 months.
Fitch's similarly rated retail coverage includes Rite Aid Corporation, which was recently downgraded to 'C' from 'B-'/Negative following its proposed tender offer, which Fitch views as a Distressed Debt Exchange (DDE), as it requires bondholders to consider a below-par tender offer or risk collateral and covenants being stripped from the notes. Rite Aid's credit profile assessment also considers its weak position in the relatively stable U.S. drug retail business, its limited FCF, and its high adjusted leverage (capitalizing rent expense at 8x), projected in the mid-7x range in 2022.
Key Assumptions
Fitch expects Party City's 2022 revenue could decline around 2% (essentially flat in 1H22) to $2.1 billion, despite nominal benefits from inflation, on some pullback in consumer spending in the category and possible trade-down to lower priced competitors such as general merchandisers and discounters. Revenue could be flat in 2023 as a result of a softening macro-economic backdrop, before growing modestly thereafter assuming some of Party City's topline initiatives are successful.
EBITDA in 2022 is expected to be around $110 million, down from $240 million in 2021 driven by higher supply chain and input costs, higher inventory costs and lower sales. Margins could decline to the 5% range in 2022 from 11% in 2021. Assuming some rebound in margins over the next several years, driven by cost cutting initiatives and gradual reduction in supply chain and input costs, EBITDA could improve toward $175 million by 2024, with margins around 9%.
FCF, which averaged around breakeven over the past four years, could be an outflow of around $270 million in 2022 given challenged EBITDA and inventory build. FCF could be positive in 2023 as a result of modest EBITDA improvements and the unwinding of some working capital, and break even to positive in 2024.
Adjusted debt/EBITDAR (capitalizing leases at 8x), which was 7.0x in 2021, could be in the mid 10x range in 2022 on EBITDA declines and ABL draws to fund high working capital outflows in 2022. Assuming improvements in profitability margins EBITDA could reach $175 million, which with some deployment of FCF toward debt reduction, could lead to adjusted leverage declining toward low 8x by 2024.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade could occur if the company's operating and liquidity profile improves materially, evidenced by sustained EBITDA above $150 million and positive free cash flow generation. The company would also need to successfully address its 2023-2026 maturities without a restructuring.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A downgrade would occur if the company were to engage in a default-like process or if the company is unable to fund ongoing operations through internal and external liquidity sources.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Liquidity pressured by operating challenges: As of Sept. 30, 2022, Party City had approximately $120 million of liquidity, comprised of $29.8 million in cash and $92 million in availability on its various asset-based revolvers ($77.3 million on the Party City Holdings Inc. ABL and $14.4 million on the Anagram Holdings LLC ABL). The company's primary ABL is a $545 million facility plus $17 million FILO tranche which matures in February 2026. In 2021, Party City's subsidiary Anagram obtained a $15 million ABL which matures in May 2024.
Party City's $545 million ABL credit facility has a 1x Fixed Charge covenant that springs if excess availability on any day is less than the greater of: (a) $46 million and (b) 10% of the Total Line Cap (as defined in the company's credit agreement).
The company's debt structure consists of its ABL facilities, which are limited by a borrowing base comprised mostly of inventory, $23 million of unsecured notes due August 2023 and approximately $1.2 billion of notes maturing in 2025/2026. Party City's accelerating operating challenges and Fitch's weakening confidence in EBITDA and cash flow stabilization have led to Fitch's reduced confidence in the company's ability to address its 2025/2026 maturities without a default.
The $1.2 billion of notes due 2025/2025 is comprised of secured and unsecured notes issued by Party City and secured notes issued by its helium balloon business subsidiary Anagram. Party City has $750 million of secured notes due February 2026 and $162 million of secured notes due July 2025; these notes tranches are pari passu and are secured by most of Party City's remaining assets, with a second lien on ABL collateral. Party City also has $92 million of unsecured notes due August 2026. Anagram has $119 million in first-lien secured notes due August 2025 and $94 million in second-lien secured notes due August 2026.
Liquidity pressured by operating challenges: As of September 30, 2022, Party City had approximately $120 million of liquidity, comprised of $29.8 million in cash and $92 million in availability on its various asset-based revolvers ($77.3 million on the Party City Holdings Inc. ABL and $14.4 million on the Anagram Holdings LLC ABL). The company's primary ABL is a $545 million facility plus $17 million FILO tranche which matures in February 2026.
In 2021, Party City subsidiary, Anagram, obtained a $15 million ABL, which matures in May 2024. Party City's $545 million ABL credit facility has a 1x Fixed Charge covenant that springs if excess availability on any day is less than the greater of: (a) $46 million and (b) 10% of the Total Line Cap (as defined in the company's credit agreement).
The company's debt structure consists of its ABL facilities, which are limited by a borrowing base comprised mostly of inventory, $23 million of unsecured notes due August 2023 and approximately $1.2 billion of notes maturing in 2025/2026. Party City's accelerating operating challenges and Fitch's weakening confidence in EBITDA and cash flow stabilization have led to Fitch's reduced confidence in the company's ability to address its 2025/2026 maturities without a default.
The $1.2 billion of notes due 2025/2026 is comprised of secured and unsecured notes issued by Party City and secured notes issued by its helium balloon business subsidiary Anagram. Party City has $750 million of secured notes due February 2026 and $162 million of secured notes due July 2025; these notes tranches are pari passu and are secured by most of Party City's remaining assets, with a second lien on ABL collateral. Party City also has $92 million of unsecured notes due August 2026. Anagram has $119 million in first-lien secured notes due August 2025 and $94 million in second-lien secured notes due August 2026.
Recovery:
Given the various collateral packages, Fitch has performed separate recovery analyses for Anagram and the balance of Party City's businesses. Party City ex Anagram Fitch's recovery analysis for Party City is based on a going concern value of approximately $625 million, versus approximately $580 million from an orderly liquidation of assets, much of which is comprised of inventory. Post-default EBITDA was estimated at around $125 million, which compares with just under $200 million of EBITDA forecast at Party City ex-Anagram longer term.
The going-concern EBITDA assumes that the company closes around 25% of its weaker-performing store base, having already closed around 75 or approximately 8% over the past several years as part of a store optimization process. EBITDA margins could improve toward 9% on cost reductions. This scenario would yield revenue of approximately $1.4 billion, down 25% from 2021 levels, and EBITDA of $125 million.
A multiple of 5.0x to EBITDA is applied, at the midpoint of the 4.0x-6.0x multiple range observed in Fitch retail bankruptcy case studies given Party City's leadership position in its category mitigated by concerns regarding weakening category defensibility to intrusive channels. Together these estimates yield a $625 million going concern value.
After deducting 10% for administrative claims, the remaining $563 million would lead to outstanding recovery prospects (91%-100%) for the ABL, which is assumed to be drawn 70% at default. The ABL is consequently rated 'B'/'RR1'. The $750 million of first-lien secured notes and $162 million of other first-lien secured notes, which are pari passu, are expected to have below average recovery prospects (11%-30%), and are thus rated 'CCC-'/'RR5'. Party City's $115 million of unsecured notes are expected to have poor recovery prospects (0%-10%) and are thus rated 'CC'/'RR6'.
Anagram:
Fitch's recovery analysis for Anagram is based on a going concern value of approximately $180 million, versus approximately $45 million from an orderly liquidation of assets, which is comprised of receivables, inventory and manufacturing assets. Post default EBITDA was estimated at around $30 million. This compares to Party City's indication of approximately $30 million in EBITDA on around $153 million of revenue through the first three quarters of 2022 (ending Sept. 30, 2022).
The $30 million going concern EBITDA represents the scenario of a loss of some of Anagram's largest retail and distributor customers, yielding around $150 million in revenue, offset by some expense management to generate 20% EBITDA margin. Fitch assumes Anagram could fetch a 6x multiple, near the midpoint of Fitch's consumer products bankruptcy studies, given the business' strong market share and relatively stable category over the long term.
After deducting 10% for administrative claims, the remaining $162 million would lead to outstanding recovery prospects (91%-100%) for the $15 million ABL (assumed 70% drawn) and $119 million first lien secured notes, the latter of which is rated 'B'/'RR1'. The $94 million second lien secured notes would be expected to have average recovery prospects (31%-50%), and is thus rated 'CCC'/'RR4'.
Issuer Profile
Party City is the leading party-supply retailer in the U.S., with 761 company-owned stores as of September 2022, e-commerce operations, and a large wholesale operation that supplies retail operations and third parties.
Summary of Financial Adjustments
Summary of Financial Statement Adjustments:
Adjustments in 2021 included inventory disposal, restructuring charges and one-time legal and other expenses.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
PARTY CITY HOLDCO INC. 
