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Toys 'R' Us files for Chapter 11 bankruptcy

September 18, 2017

Toys “R” Us Inc. filed for bankruptcy as the retailer, loaded with debt in a buyout more than a decade ago, failed to keep consumers from abandoning its stores for the lower prices and convenience of online shopping.

The company filed Chapter 11 documents late Monday in U.S. Bankruptcy Court in Richmond, Virginia. The chain secured $3 billion in debtor-in-possession financing to stay open while it restructures, according to a company statement.

The Indianapolis area is home to three Toys "R" Us stores—in Castleton, Greenwood and at 9251 East Washington St.—and two Babies "R" Us stores.

The bankruptcy filing is the latest blow to a brick-and-mortar retail industry reeling from store closures, sluggish mall traffic and the threat of Amazon.com Inc. More than a dozen major retailers have filed for creditor protection this year, including Payless Inc., Gymboree Corp. and Perfumania Holdings Inc., all of which are using the Chapter 11 process to close underperforming stores and expand online operations.

Much of the toy merchant’s debt is the legacy of a $7.5 billion leveraged buyout in 2005 in which Bain Capital, KKR & Co. and Vornado Realty Trust loaded the company with debt to take it private. Since then, the Wayne, New Jersey-based chain has struggled to dig itself out.

CEO David Brandon took over Toys “R” Us in 2015 and sought to make shopping there a more enjoyable experience. Last year, he set out a vision of kids “dragging their parents to our stores because they want to see what’s going on.”

The retailer introduced the “Hot Toy Finder,” which tells customers exactly where in their local store to find the items featured on its “ Holiday Hot Toy List.” The chain, which has provided the annual list of the 50 hottest toys for 20 years, also offered price matching and free layaway.

While Brandon made some progress reducing liabilities, he ultimately was unable to resuscitate the closely held chain’s fortunes. The company reported a net loss of $164 million in the quarter ended April 29, compared to $126 million for the same period in the prior year. It hasn’t shown an annual profit since 2013.

The company sells toy and baby merchandise in more than 1,500 Toys “R” Us and Babies “R” Us locations worldwide and through websites including Toysrus.com and Babiesrus.com.

Charles Lazarus opened Children’s Bargain Town, a baby-furniture store, in Washington in 1948, according to the Toys “R” Us website. He added toys two years later and opened the first Toys “R” Us, modeled after self-service supermarkets, in 1957. Lazarus stepped down as chairman and CEO in 1994. Two years later, the first babies “R” Us opened.

Filing for bankruptcy could allow Toys “R” Us to restructure $400 million in debt that comes due next year, potentially letting the chain rebuild as a leaner organization. The retailer has hired a claims agent, which typically helps with administering such a process, people with knowledge of the situation said last week. And its vendors have been curtailing shipments amid concern that Toys “R” Us might not be able to pay its bills.

“This filing is really a buildup of financial problems over the past 15 years,” said Jim Silver, an industry analyst and the editor of toy-review site TTPM.com. “Finally, the straw broke the camel’s back.”

With speculation of the bankruptcy mounting, shares of Toys “R” Us’s vendors tumbled on Monday. Mattel Inc., the maker of Barbie and Fisher-Price, fell 6.2 percent—its worst decline in seven weeks. Shares of Hasbro, the company behind Monopoly, Nerf and Transformers, dropped 1.7 percent.

Bankruptcy financing

JPMorgan Chase & Co., Barclays Plc, Goldman Sachs Group Inc. and Wells Fargo & Co. are said to be vying to provide financing for Toys “R” Us while it goes through bankruptcy.

The debtor-in-possession loan—known as a DIP—could be as much as $3 billion, a person with knowledge of the discussions said.

Ratings agencies have rushed to cut their credit ratings on Toys “R” Us to reflect the sinking market sentiment, indicating just how rapidly things have unraveled at the retailer. S&P Global Ratings and Fitch Ratings both downgraded the toy seller Monday, citing media reports and market data pointing to an increased possibility of a broad restructuring. S&P cut its rating to CCC-, the third-lowest level. It had the retailer rated B- just two weeks ago, and Moody’s Investors Service still has a B3 rating and stable outlook for the name.

Much of the toy supplier’s debt is the legacy of a $7.5 billion leveraged buyout more than a decade ago. In 2005, Bain Capital, KKR & Co. and Vornado Realty Trust loaded Toys “R” Us up with debt to take it private. Since then, the Wayne, New Jersey-based chain has struggled to dig itself out.

Interest expenses

Some years, the company had to spend as much as half a billion dollars on cash interest expenses alone, according to Bloomberg Intelligence analyst Noel Hebert. That left Toys “R” Us with less cash to put toward store expansions, merchandising, and—crucially—the growth of its online presence.

“With these debt levels, how much actual flexibility do you have in this environment?” asked Charles O’Shea, who covers Toys “R” Us for Moody’s Corp. “You have to invest online—because your principal competitors there are really good—and you’ve got to deal with the debt load and your maturities on top of that. The pie is only so big.”

Chapter 11 also will help the company get out of burdensome leases, said Craig Johnson, head of Customer Growth Partners.

“The idea being, after a period of time, you work yourself out of Chapter 11 and you go on being a smaller, but financially more healthy retailer,” he said.
Domino’s Veteran

‘Price war’

Brandon, 65, lamented the price competition during a conference call in June.

“Make no mistake about it, there is a little bit of a price war situation right now,’’ Brandon said.

As the woes have piled up, the cost of insuring against default on Toys “R” Us debt has surged. Prices on six-month and one-year swaps have climbed to record highs, suggesting the market is pricing in all-but-certain odds of a Chapter 11 filing, which protects companies against creditors during a reorganization.

Credit default swaps expiring in December traded at more than 75 points upfront Monday. That means it would cost about $7.5 million to insure $10 million of Toys “R” Us debt.

Toys “R” Us’s bonds have been hammered. Its 7.375 percent notes due 2018 traded for as little as 18 cents during Monday’s session, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That’s down from 97.25 cents on Aug. 30.

If Toys “R” Us can get its debt under control again, the chain still has promise, TTPM’s Silver said. Its earnings before interest, taxes, depreciation and amortization has been good, he said.

“If they didn’t have the debt would be making $500 to $600 million a year in profit,” he said. “The problem is the debt.”

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