WOLF STREET–Brick-and-mortar retail meltdown strikes again – this time, Toys R Us. In what is a classic sign, the company has hired mega law firm Kirkland & Ellis, whose bankruptcy-and-restructuring practice is considered a leader in the now booming bankruptcy-and-restructuring industry.
Toys R Us, with 1,694 stores globally, has $5.2 billion in long-term debt, according to its latest quarterly report, and sports a negative equity of $1.3 billion. Quarterly sales declined 4.8% year-over-year, to $2.2 billion. This isn’t a one-quarter dip: sales are down 15% from the same quarter in 2012. And the net loss jumped 30% year-over-year to $164 million.
The company needs to restructure its debts, particularly $400 million that is coming due in 2018, and a bankruptcy filing is one of the options, “sources familiar with the situation” told CNBC on Wednesday.
The company, long teetering under its massive pile of debt, has been trying to refinance its capital structure. In early 2016, it disclosed that it was working with the biggest investment banks on Wall Street – BofA Merrill Lynch, Goldman Sachs, and Lazard – to do so. Last year, it was able to refinance some of its debt, but that wasn’t enough. Now lenders are shying away from overleveraged brick-and-mortar retailers, given the ongoing meltdown of overleveraged brick-and-mortar retailers, particularly those owned by private equity firms and hedge funds.
In response to CNBC’s questions, a Toys R Us spokeswoman responded with corporate blah-blah-blah:
“As we previously discussed on our first quarter earnings call, Toys R Us is evaluating a range of alternatives to address our 2018 debt maturities, which may include the possibility of obtaining additional financing.”
“We expect to provide an update about these activities, as well as the many initiatives underway to provide an outstanding customer experience in our global retail locations and webstore during the holiday season, during our second quarter earnings call” [on September 26].
As in so many cases in the brick-and-mortar retail meltdown, there is a private-equity angle to it. PE firms Kohlberg Kravis Roberts (KKR), Vornado Realty Trust, and Bain Capital Partners acquired the publicly traded shares of Toys R Us in a leveraged buyout during the LBO boom in 2005 in a deal valued at $6.6 billion. They funded the acquisition in large part by loading up the company with debt — hence “leveraged buyout.”
Even at the time, the toy retailer was struggling with competition from Walmart, online retailers, and brick-and-mortar toy stores. Competition is a good thing, but not if the company has too much debt.
So here’s what the three PE firms did to Toys R Us: they stripped out cash and loaded the company up with debt. And these are the results: At the end of its fiscal year 2004, the last full year before the buyout, Toys R Us had $2.2 billion in cash, cash equivalents, and short-term investments. By Q1 2017, this had collapsed to just $301 million. Over the same period, long-term debt has surged 126%, from $2.3 billion to $5.2 billion.
This table shows the astounding results of asset stripping and overleveraging. It takes a lot of expertise and Wall Street connivance to pull this off. So whatever happens to Toys R Us, the PE firms already extracted their wild profits:
Over the same period (2004 through 2016), annual revenues have remained essentially flat at just over $11 billion.
Bain Capital is also the PE firm behind the 2010 leveraged buyout of children’s clothing retailer Gymboree with 1,281 stores, which filed for bankruptcy in June.
After extracting enough cash from Toys R Us and loading it up with a debilitating pile of debt, the three PE firms tried to unload it to the unsuspecting public in an IPO in 2010. They were hoping for an additional payday, the icing on the cake, so to speak. But they had to scuttle their efforts due to “challenging market conditions.”
Yet toy industry sales have been “robust,” growing by 5% in 2016, and by a compound annual rate of 5% since 2013.
Incapably managed by the PE firms, Toys R Us has been losing market share in its struggle with online retailers, particularly Amazon, and with Walmart at every level, and with other toy stores. Nevertheless, if the company weren’t overleveraged and didn’t have PE firms leeching off it, its slowly declining revenues and thinning profits turning to losses wouldn’t be the end of the world.
But once PE firms sink their teeth into a company, there is no margin for error. And once lenders and bondholders finally get skittish – often the same whose connivance made the LBO and the asset stripping possible – then the whole house of cards, so to speak, comes tumbling down.
This baby is going down the tubes at an ever faster speed. Read… Sears Revenues to Hit Zero in 3 Years. But Bankruptcy First