Wherehouse Files for Bankruptcy

Retailing can be a rough ride even in the best of times. In the current climate, it’s especially hard for those trying to make a go of it with recorded music.

In early January, SoundScan reported an 8.7% drop in CD sales for 2002, compared with the previous year. (Other sources estimated the slide at as much as 11%.) The sales tracking organization stated that the decline was the sharpest, year-to-year, since the introduction of its index 11 years ago. The decline was especially painful for music labels and retailers, given that sales dropped by a similar amount in 2001 compared to 2000. The music industry is entering the third year of the most prolonged slump in its history, with no hope for a turnaround.

On January 21, Wherehouse Entertainment, Inc. officially threw in the towel with a petition for protection under Chapter 11 of US bankruptcy law. The Torrance, CA–based retailer will soon close 120 stores, in addition to the 30 it has already closed. The remaining 250 stores, spread among 23 states, will be remodeled or reorganized to provide more interactive features, such as listening kiosks, and will include a wider range of products than CDs and DVDs.

Company officials, predictably, recited the music industry’s mantra about the causes of the bankruptcy—"downloading, file-sharing, and CD burning." Curiously, unlike some other big music retailers, Wherehouse did a brisk business in used CDs, with each store sporting several large bins devoted solely to used discs. Music fans could swap their old discs five-for-one for new ones during "Wherehouse Trade-in Tuesdays." Executives acknowledged that competition from mass-market discounters like Wal-Mart had taken a devastating bite out of the Wherehouse bottom line.

The January 21 filing was the company’s second trip to bankruptcy court in eight years, making it one of several big-business repeat offenders, dubbed "recidivist bankruptcies" by the Wall Street Journal. A Chapter 11 bankruptcy provides protection from creditors while a company restructures, and is limited by law to no more than once every seven years. "The practice is coming to be referred to as Chapter 22, which is Chapter 11 multiplied by two," bankruptcy attorney Marty Zohn wisecracked to Reuters reporter Sue Zeidler.

Wherehouse filed under Chapter 11 in 1995, before the Internet and CD burners were major irritants for the music business. The company emerged from bankruptcy in 1997, and in 1998 acquired the Blockbuster Music chain, a move that was questioned by many observers.

Wherehouse claimed assets of $228 million and liabilities of $222.5 million, with about $50 million owed to the music industry's "Big Five" conglomerates, listed collectively in the filing as secured creditors. That will get them paid first; unsecured creditors generally get little or nothing in such circumstances.

Refusing to accept the proposition that large music stores are dinosaurs, Wherehouse president and CEO Jerry Comstock told reporters that his company would emerge from bankruptcy healthier than ever. "The retail music environment has changed dramatically in the last three years," he stated, adding, "Through the Chapter 11 process we believe Wherehouse will be able to restructure its operations." Comstock said bankruptcy is the best way to "position Wherehouse to compete effectively in the new music industry . . . We are confident Wherehouse will emerge from this process as a stronger, leaner, more efficient operation."

The Wherehouse bankruptcy came just two weeks after a decision by Best Buy, Inc. to close many of its Musicland stores. The Eden Prairie, MN–based chain is North America's top electronics retailer, and enjoyed a reasonably successful 2002 except for its music chain, which has dragged down the parent company's bottom line ever since it was acquired two years ago. On January 9, Best Buy announced that it would close approximately 107 of its 1300 Musicland stores, including some Sam Goody locations, and lay off about 700 workers. Industry observers had expected more drastic cuts; at the beginning of the year, the anticipated number of closings was closer to 150.

Best Buy's electronics stores were targets of the music industry's ill-conceived "MAP" (minimum advertised price) program, which attempted to provide some support to retailers who were having trouble competing with mass marketers offering CDs at or below cost to lure customers into their stores. MAP became a class-action price-fixing suit eventually joined by attorneys general from 41 states, and was recently settled to the tune of $143 million, to be paid by the music industry to states and individuals. Selling discs below cost essentially let Best Buy's namesake stores undercut the parent company's music store division. The closings are the result.

Analysts asked about the Musicland situation were nearly unanimous in stating that Best Buy's best move is to get out of the music business as quickly as possible. The Wall Street Journal noted that the Musicland closings could have a negative effect on certain financial markets, in particular "REIT" (real estate investment trusts) partnerships that are heavily invested in shopping malls, where most Musicland stores are located. Some Musicland stores could be closed before their leases expire, according to the Los Angeles Times.