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Toys“R”Us, re-birth or last breath?

  • Is leveraged buyout dangerous for businesses?
  • Can online players capture the toy industry?
  • An outlook on current operations of Toys“R”Us

 

Toy business has a vast scope and requires a lot of innovation. One of the key names in the toy industry is of Toys"R”Us. This is a US-based company, which was incorporated as a baby furniture store in 1948 and diversified into toys in 1957. In the last 7 decades, the firm has come a long way with its present-day operations in 37 countries, 875 stores in the US, 765 overseas stores and 245 licensed stores. The overall business dynamics changed with the company being one of the major retailers of toys in the US up till 2000, the entity faced stiff competition from the big box retailers like Walmart and online giants such as Amazon. Globally, the three big markets for toys are in the US, China and Europe. Walmart and Toys”R”Us are the major players in the US market.

Ironically, Toys”R”Us filed for bankruptcy in 2017, was it a re-birth or bust of a retail empire?

One of the arguments given by analysts for the bankruptcy was the growing trend to purchase toys online. In toy business, the target segment and the buyers are distinct. The target segment is children while buyers are adults, who would prefer to buy toys at the cheapest price. Hence, it becomes easier for e-commerce websites to attract these buyers through discounts and ease of shopping. While Toys”R”Us has a website to sell its products, the online sales of toys for Amazon and Walmart is way more than Toys”R”Us. Notably, increasing trend of online shopping is not only affecting toy business but the retail industry as a whole. The big names such as Payless Inc. (the discount shoe seller), Gymboree Inc. (apparel and accessories) and Perfumania Holding Inc. (fragrance retailer) lost to the online shopping and filed for bankruptcy in the recent years. The largest bankruptcy prior to  Toys”R”Us was that of the Kmart (2004) in the US retail segment.

But on a positive note, this is still not a big threat for Toys”R”Us as the revenue from its stores is significantly greater than the online revenue of toys from Amazon and Walmart. Additionally, Toys”R”Us has a presence in 36 nations apart from the US. The e-commerce penetration in the world is yet to replicate the extent of the US. The overseas stores are expected to bring in perennial revenue to the company in the next decade. While the total revenue of Toys”R”Us declined in the past 5 years in the US, on the contrary, its overseas revenue increased in the same period.

Televisory believe, the major cause for bankruptcy was the leveraged buyout (2005) for Toys”R”Us, when the largest investors Bain Capital, KKR and Vornado Realty invested $1.3 billion (out of the total deal value of $6.6 billion) and $5.3 billion through debt. The investment added a debt of $5.3 billion to the balance sheet of Toys”R”Us. Hence, out of this, the remaining amount to be paid was $4.6 billion and $400 million was the interest, which was due in 2017 and the company was unable to pay the amount. Toys”R”Us filed for bankruptcy under the Chapter 11 in the US and Canada (Sept. 2017). According to Chapter 11, a business file for protection against bankruptcy (Chapter 11) though it still has control on operations in the company.

The long-term borrowings were $4,642 million (as on 2016) for the firm and it comprised credit facilities, debentures and term loans. The majority of debt facilities will expire in 2021. The below graph shows the current portion of the debt which needs to be paid every year, this will be the highest in 2019, but the liquidity is not sufficient to meet the future demand on debt. The company is not in a position to operate with the existing cash flow. In 2016, the available cash for operations was $701 million, of which $400 million was interest payments to service the debt. Toys”R”Us appointed Kirkland and Ellis firms for a possible solution on the payment of $400 million at the end of 2017.

Thus, filling for bankruptcy provided flexibility in the financial decision-making process. Moreover, under the restructuring filed by the company, an additional financing will be provided by the JP Morgan so that the firm can operate smoothly. In addition, suppliers like Mattel and Hasbro are also supporting the company as approximately 15 to 20% of their sales are recognized through Toys”R”Us. The company informed its customers and suppliers that stores will remain open and will operate as usual. It records 40% of the total sales around Christmas and New Year holidays, hence, the timing of its bankruptcy filing stand well as at least it continues to run through the period of good sales with revised commitments to banks, suppliers and stakeholders. Toys”R”Us is already working with suppliers and vendors for maintaining the inventory levels and delivering its products on time. 

Presently, Toys”R”Us is engaged in settling of its debts and finding solutions for its forthcoming payments. The company managed its payments for a decade but now it seems difficult as Toys”R”Us is spending a major portion of its EBITDA for the interest payments. The firm has a huge amount of debt payments to make in the next two years, which is almost equal to its sales. A comparison of this with the liquidity levels reveals that one-fourth of the total debt is due in the following two years. The operating profit is increasing from 2013 but is not at the same pace with which debt repayments are approaching.

The silver lining is that Toys”R”Us can continue its operations (as per the provisions of Chapter 11 bankruptcy) while also having a potential to add new stores overseas where its revenues are increasing YOY. Toys”R”Us can improve upon its balance sheet and see the light at the end of the tunnel in a similar way as GM (General Motors), which did not close shop when it declared Chapter 11 bankruptcy. Lastly, suppliers are also supporting the company, which is a big plus.