BigTime Debt is Coming Home to Toy's R Us and It Ain't Playing Around
Capital Thinking • Issue #98 • View online
“I’m an Ayn Rand-loving capitalist who likes to jump around in big piles of money.
And I still think what private equity did to Toys R Us was criminal.”
- Jared Dillian @dailydirtnap
Well, OK then.
This little piece popped up in my Twitter feed from Dillian the other day and I was reminded of an email conversation I had with a friend of mine, Ray Alcorn, earlier in the year on this very subject.
Here’s the conversation:
Hey!
-Found this in my spam folder and since I didn’t want to sign up for the “Full Report”, I thought I’d send you this little piece of it.
Toys R Us Downfall Reiterates Changing Retail Climate; Potential Retail Replacements to Emphasize Experiences
New age of retail forces adaptation. The rapidly evolving retail landscape bypassed Toys R Us, resulting in a bankruptcy protection filing and ultimately the announced closures of roughly 800 locations.
Well-established brands shuttering stores have become a common theme in recent years as companies who fail to adapt to the new retail reality operate with outdated strategies.
The company’s weakened balance sheet hampered efforts to make investments to modernize its business model and compete with Amazon, Walmart and Target.
Due to the firm’s limited online capabilities and inability to transform into an experiential retailer, consumers soon found quicker and cheaper ways to purchase toys that bypassed this traditional toy powerhouse.
Strong Internet competition led to Toys R Us’ diminishing market share and the competitive gap slowly widened until it was beyond the company’s ability to bridge.
I also figured you’ve already seen most of the articles on TRU already, but I found it interesting that - at least in the blurb above - no mention is made of the capital demands from the buyout firm, Bain Capital (among others).
Frankly, I don’t know whether or not these deals are still on-going. Most likely, the cash has simply moved on to an easier target (software companies?).
In any case, many of these deals were completed before the Great Recession which was a different world altogether.
Thoughts?
(from Ray)
Well, my take on TRU is that the bankruptcy is no surprise.
As you surmise, the failure had nothing to do with strategy and entirely due to debt (mostly real estate related, natch).
For 2017, interest expense = 100% of operating profit, which in the past few years had been improving.
For a great overview without getting lost in the weeds of deal-structuring, see the link here : https://www.bloomberg.com/news/articles/2018-03-09/toys-r-us-downfall-is-ominous-reminder-about-debt-laden-deals
But that is not to say there were not operational challenges.
As the Bloomberg article observes:Interest payments on debt tied to the LBO made it difficult for Toys “R” Us to invest in its operations or technology to lure online shoppers.
I have no insight other than as interested bystander in what form retail will become. I am reminded off the aphorism I included as a chapter head in DG-CRE:
We tend to overestimate the effects of change in the short run and underestimate its effects in the long run.
Retail is indeed in the midst of a reset, and by extension so is retail real estate.
The current landscape is gloomy, more stores contracting than expanding, falling rents, increasing concessions, and higher development costs. And this in the middle of “good-times”, e.g. low rates, expanding economy, tax-breaks, low/no inflation. Begs the question, what happens when bad times hit?
The retailers all point at e-commerce and Amazon as the culprit. Not so. Online sales is still <5% of total retail sales, and Amazon accounts for a bit over 40% of that number. Online is projected to go to 20$ in the next five years, but a goodly portion of that increase is a bigger pie, not skinnier slices.
(and I'm back)
I fully expect to see a lot more of these deals tank in the coming months. Increasing costs, lower demand, and higher interest rates will finally tip many of these into bankruptcy.
We’ll take a look at how these same conditions are playing out in the food industry tomorrow.
Here’s a hint: It isn’t a pretty picture.