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How Toys R Us Collapsed

I've got fond memories of going to Toys R Us as a kid. I don't recall going often, but when I did, it was like this amazing toy oasis. It was the only thing in my young mind that matched the toy stores I saw in movies. So, I was a bit sad to see the news that they are going out of business, closing all of their U.S. stores.

My first thought of course was, "well, Amazon and Walmart destroyed them." And, "they didn't adapt to the online world fast enough." And many articles echo those thoughts, to varying degrees. I'm sure to some extent that's true...but it's really not the biggest reason. Toys R Us was bled dry by a small group of private equity and investment trust groups. There are a few good articles out there on it, which I'll link, but I want to sum up a couple key pieces.

The gist of the scam:

Vornado Realty Trust, KKR and Bain Capital financed 80 percent of the purchase of Toys “R” Us, so while the company sold for $6.6 billion, the trio only contributed $1.3 billion. As part of the purchase agreement, the companies also agreed to take responsibility for all of Toys “R” Us’s long-term debt obligations, which at the time totaled $2.3 billion. Once Toys R Us was taken over, however, the debt Vornado Realty, KKR and Bain used to acquire it was pushed back onto the company, skyrocketing its debt obligations to $7.6 billion.

How it killed Toys R Us:

Toys “R” Us has been paying $400 million a year to service these debts. This money could have been used to lower prices or improve the company’s website—not to mention raising pay to its employees—but instead went to paying off creditors. Last year, the company reported a loss of $29 million. If it weren’t for these debt payments, Toys “R” Us would have run a substantial profit.

Bain Capital, if you'll remember, was Mitt Romney's firm. They are famous for doing exactly this to companies; in fact, Bain is reponsible for doing pretty much the same thing to KB Toy Stores (remember them?), who were once the nation's second largest toy retailer. So, thanks a bunch for destroying the largest toy stores.

Some other sources:

Just a little more fuel for the fire. Apparently, someone offered to buy a few of the remaining Toys R Us stores in the U.S. , plus all of the stores in Canada. It was some toy company. Anyway, the ownership group rejected the offer, which I believe was about $600 million.

I don't know know why they rejected the bid. But, I can speculate! Right now, the private equity groups that caused this mess with their leveraged buyout/debt dumping scheme are trying to bleed Toys R Us completely dry before dropping them on the scrap heap. Selling a portion might impact how much they could make from this scam (repaying too much to debt holders?).

We really need regulation of this type of thing. Every person who I tell about this says the same thing: "Is that legal?!"

Nice to see a little fresh anger on this topic. A recent article from the Washington Post:

Toys R Us isn’t paying severance to its 30,000 workers who will lose their jobs as the retailer shuts down, even though it doled out millions in executive bonuses a week before it filed for bankruptcy. Now, some workers are calling on lawmakers to create new rules that would require bankrupt companies backed by private-equity firms to provide compensation to their workers.

On Friday, more than a dozen workers met with lawmakers in New Jersey, where Toys R Us is based, to push for severance pay. Workers also called for new regulations on leveraged buyouts, as well as windfall taxes that would prevent private-equity firms from running a business into the ground and then walking away with huge sums of money.

Just as a reminder, the private equity firms who purchased Toys R Us did so using a scam called a "leveraged buyout." They borrowed huge sums of money, in this case billions of dollars, and used the loan to buy Toys R Us. Then they dropped that loan onto Toys R Us' books. With suddenly billions of dollars in additional debt, most companies fall apart.

Last year, Toys R Us awarded executives $8 million in bonuses a week before filing for bankruptcy. A few months later, the company got approval from a bankruptcy judge to pay up to $21 million in additional bonuses to executives if they met certain performance goals. (That money was never awarded because the company’s performance fell short.) Chief executive Dave Brandon received $11.25 million in compensation last year.

Of course, the private equity firms milk the bankrupt company of anything they can, and in this example, the Toys R Us executives who guided the company to this fate scored millions themselves. Nice little reward for this Dave Brandon guy in exchange for allowing this to happen. As I've said, it's absurd there is no regulations against this.

Others that have filed for bankruptcy following leveraged buyouts include Nine West, Claire’s, Gymboree, True Religion and Payless Shoe Source.

Oh cool. I didn't even know those were leveraged buyout victims too.

In the case of Toys R Us, financial filings show that the company was handing over $400 million a year to pay back its debt, often at the expense of turning a profit. Recently, it was burning through $50 million to $100 million in cash each month as it tried to dig its way out, according to court documents filed in March. The retailer also paid $470 million in advisory fees, interest and other payments to Bain Capital, KKR and Vornado since 2005.

The firms did not respond to requests for comment.

No kidding? I can't believe they wouldn't want to talk about this scam. They don't want people discussing this insanity, because then the gravy train might end.

Another article on the topic from the Atlantic: The written article is a good read, but I'd recommend clicking just for the excellent graphic at the top by Rebekka Dunlap.

I know I'm hammering a lot of the same points over and over, but they are important and worth repeating in my opinion.

Less attention was paid to the albatross that Bain, KKR, and Vornado had placed around the company’s neck. Toys “R” Us had a debt load of $1.86 billion before it was bought out. Immediately after the deal, it shouldered more than $5 billion in debt. And though sales had slumped before the deal, they held relatively steady after it, even when the Great Recession hit. The company generated $11.2 billion in sales in the 12 months before the deal; in the 12 months before November 2017, it generated $11.1 billion.

Saddled with its new debt, however, Toys “R” Us had less flexibility to innovate. By 2007, according to Bloomberg, interest expense consumed 97 percent of the company’s operating profit. It had few resources left to upgrade its stores in order to compete with Target, or to spiff up its website in order to contend with Amazon. “It’s true that they couldn’t respond to Amazon,” Eileen Appelbaum, a co-director of the Center for Economic and Policy Research, told me. “But you have to ask yourself why.”

One of the narratives often popularized about capitalism is that of a small business owner, building a company and creating something that contributes to the economy. Of course there are many examples of that, and some of those small businesses grow into large businesses. I am not specifically trash talking the idea of a large business entity here (although I do have some separate issues with massive, unaccountable corporations). My beef is that I question how these private equity firms engaging in leveraged buyouts actually contribute to our system. Do they build anything? Or are they opportunistic vampires, lurking around, waiting to drain the value out of vulnerable companies?

I know capital is important to business, and that investment from outside entities can provide a company with a necessary infusion of cash. But, this whole "borrow money -> use loan to buy company -> make company take the loan over -> hollow out company's assets -> move on" scam is too much. It's not creating or building anything. It's just syphoning wealth.

Well, Toys R Us is closing its doors officially tomorrow. Curse you forever, leveraged buyout con artists.

I don't know who made this image...seems like maybe someone from Toys R Us? It's going around on social media today, but there's no source attribution that I can see. It's a pretty effective kick right in the childhood memories:

Bye Toys R Us

Now that Toys R Us is gone...who's the next leveraged buyout victim? We've got a couple of options, unfortunately. And they're at different stages in the process.

First on tap might be J. Crew. Their forced debt load is lower; $1.7 billion compared to Toys R Us' $5 billionish. But, once again it involved a loan taken out by the private equity firm to buy them, then the loan was added to the company's books (source here):

Though falling sales have plagued the chain for years, its biggest problem doesn't seem to have anything to do with an inability to keep up with the latest trends.

It's actually the millions of dollars in debt the retailer has carried since 2011, when TPG Capital and Leonard Green & Partners helped it buy itself through a $3 billion leveraged buyout, taking the company private.

J.Crew now has around $1.7 billion in debt, which it is paying in quarterly payments, the Washington Post reported.

"There are so many issues here, but the biggest one is a crippling debt load - we're talking $30 million a quarter just in interest payments," Neil Saunders, managing director of GlobalData Retail, told the Washington Post. "It's an eye-watering number and it makes a turnaround just about impossible."

They're a bit behind J. Crew's timeline, but Gamestop may be another future victim. They are apparently considering a buyout from a private equity firm (source here):

Video game chain GameStop, which like many other retailers has fallen on some pretty harsh times in the age of digital distribution platforms and online sales, is considering a buyout from a private equity firm.

According to Reuters, people familiar with the matter told them GameStop has secured a financial adviser to help with buyout discussions as its stock price has continued to slide and its former CEO Michael Mauler departed for “personal reasons” in May

Private equity buyouts often involve loading the companies involved with debt, and usually precede radical restructuring of a company’s operations like layoffs or liquidating assets to help pay back the new creditors. In some cases, this means undercutting the company’s operations in the long term to produce a short-term profit bump that the private equity firm can use to flip the company for a profit. As Rolling Stone noted in 2012:

It takes several years before the impacts of this predatory activity – reduced customer service, inferior products – become fully apparent, but by that time the private equity firm has generally resold the business at a profit and moved on.

I guess it's unknown at this point if Gamestop would actually be a leveraged buyout. Hopefully not, because companies don't seem to fair too well from those. It does appear to take years, but not exactly a recipe for longevity.

Old abandoned Toys R Us-es have all turned into Halloween stores. Isn't that perfect?

Let me see if I've got this right. Buy company using debt, give debt to that company, go bankrupt and close stores. Now you've rid yourself of the debt you used to buy the company, and purged the company of 33,000 employees. So why not open the store again! The perfect scam.

Full link above...the hedge funds that control the company are exploring opening Toys R Us again. Of course.