On September 19th the Toys “R” Us, the world’s largest retailer of toy products with more than 65,000 employees, filed for Chapter 11 bankruptcy. We were told by all of the major media outlets that the company was yet another casualty of the displacement of bricks and mortar by the digital marketplace and Americans’ changing buying habits. Specifically, the media blamed the usual suspects — Amazon and Wal-Mart — for the company’s woes:
The potential restructuring comes amid increased competition from both brick-and-mortar and online players. Big-box stores such as Wal-Mart have for years driven down prices of toys to draw parents into their stores to buy other more expensive goods. E-commerce giant Amazon.com has become an increasingly formidable competitor.
No question Toys “R” US faced serious competition. But the story is much more complicated and points to growing threat of private equity.
In 2004 Toys “R” Us was a publicly-listed company that posted a Net Profit of $252 Million on sales of over $11 Billion. The company had nearly $2 billion in working capital, and could easily service its $1.6 Billion in Long-Term Debt.
In 2005 the company was taken private in a Leveraged Buy-Out by a consortium of Bain Capital Partners, Kohlberg Kravis Roberts, and Vornado Realty Trust. The deal was valued at $6.6. billion dollars, with just over 20%– in cash, split equally– with the remainder financed by debt. So right out of the gate, Toys “R” Us had to service over $5 Billion in debt (as opposed to $1.6 prior to the buy-out).
Since the buy-out, Toys “R” Us has had to pay interest expense of $450 million, and, with high-coupon notes of $400 million coming due in 2018 the company had little choice but to file for bankruptcy protection.
What about Bain and KKR? In the 12 years of ownership, they paid themselves over $200 million in management fees.
Theoretically, the financial wizards of big PE firms are supposed to drive growth through their superior knowledge of management techniques, eliminating inefficiencies, realizing global market opportunities through their networks. The idea is to take the restructured company public again where everyone — PE investors, employees, main street investors — wins. But the reality is much different.
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.
Actually, toy industry sales have been growing at a 5% annual compound rate since 2013, so there is no reason why a financially healthy retailer couldn’t grow profitably in this environment.
Sadly, Toys “R” Us in not the only retailer destroyed by private equity. The list is long:
What many of these retailers have in common is that they were taken private in leveraged buyouts (LBOs) by private equity (PE) firms. Toys ‘R’ Us, Payless ShoeSource, The Limited, Wet Seal, Gymboree Corp., rue21, and True Religion Apparel were all LBOs. Gander Mountain can also be included in this list if you reach back to its 1984 LBO. Far too many LBOs are simply asset stripping operations by Wall Street vultures who load the company with enormous debt, then asset strip the cash from the company by paying themselves obscene special dividends and management fees.
The media will continue to blame Amazon and Wal-Mart. Meanwhile, hundreds of thousands of Americans will most likely lose their jobs thanks to these private equity firms. At the same time, the Trump Administration and Congress are focused on saving a few thousand coal industry jobs.