"I don't want to grow up!" sang Toys R Us' famous jingle from our TVs, year after year.
Unfortunately, that's not how the world works, and neither kids nor retailers get to skip out on that reality.
Retailers don't necessarily have to die, but plenty of them have been digging their own graves. The bankruptcy of Toys R Us wasn't an accident or a surprise.
In a move one can justifiably call a suicide, the company choked itself to death with debt.
The demise of Toys R Us is a lesson for all retailers, and it's a lesson for investors.
Here's the truth about what pushed Toys R Us to the edge and how not growing up led to its bankruptcy…
The Original Toy Story
On Sept. 18, Toys R Us announced it had filed for Chapter 11 bankruptcy protection in U.S. Bankruptcy Court for the Eastern District of Virginia.
The stock market wasn't rocked in the least; Toys R Us is a private company.
Founded in 1948 as a baby furniture retailer, the company's first name was Children's Bargain Town. It later merged into Interstate Stores and had its first brush with death when Interstate Stores declared bankruptcy. What emerged from that near-death experience in 1978 was a public company with a new name.
The NYSE stock symbol for Toys R Us was TOY. Now, let's jump to 2005 when a leveraged buyout (LBO) worth $6.6 billion made TOY private.
It was a group effort by buyout specialists Kohlberg Kravis Roberts & Co., Bain Capital Inc., and Vornado Realty Trust, a commercial real estate investment trust (REIT). These big kahunas and other investors put up $1.3 billion in equity and borrowed (hence the leverage) $5.3 billion to close the deal.
There's no denying that Toys is a commanding presence in its market. According to the company's website, it currently has 885 Toys R Us and Babies R Us stores in 49 states, 810 international stores, and 65,000 employees.
But it also has extraordinary debt-service obligations. On top of huge retail space lease payments, many of them above market long-term leases, the company has been burdened with approximately $400 million a year in debt service. Another $444 million is due at the end of January, and, if not renegotiated, another $2.2 billion is due in 2018.
While in the process of gearing up for the holiday season (when the company generates a whopping 40% of its annual net retail sales), CNBC reported on Sept. 6 that Toys R Us had "hired attorneys to consider its strategic options."
Vendors took immediate notice and began demanding cash for inventory the company hoped to stockpile.
That was the last straw for the heavily burdened and cash-flow-poor private retailer. It filed for bankruptcy protection less than two weeks later.
But before you cry for the principal equity investors in the LBO, who will be wiped out of their remaining equity stake, take another look.
The investors have extracted more than $470 million in fees and interest since the buyout, and several entities they control own senior and preferred company debt, which makes them first in line after suppliers and vendors if the company fails to emerge from bankruptcy and liquidates itself in the future.
You don't need to worry about them. What you need to worry about are the steps Toys R Us didn't take years ago that could have prevented this disaster.
Exactly Where Toys R Us Went Wrong
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
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