How Did Toys "R" Us Implode So Fast? The CEO Explains

Tyler Durden's picture

Reviewing first day motions from a company's chapter 11 docket, and more specifically the CEO's declaration, can be a great way to learn exactly what happened in the days/weeks leading up to a bankruptcy filing.  The company spends millions of dollars every month on expensive lawyers (Kirkland & Ellis in the case of Toys "R" Us), investment bankers (Lazard), turnaround advisors (Alvarez & Marsal), claims administrators, etc., who all spend many sleepless nights in the days leading up to a filing trying to make sure the first day motions are as informative as possible.

With those high expectations, you can imagine our surprise when we opened the Toys "R" Us CEO's declaration to find this "preliminary statement":

 

Yes, Kirkland & Ellis was paid $800 an hour (ish) to type up the Toys "R" Us jingle in a court filing.  Bravo!

In any event, once you get beyond the amateur-hour antics, CEO David Brandon explains why Toys "R" Us was forced to file for bankruptcy in such a hurry.  While debt service on a excessively levered capital structure was a big part of it, Brandon explains that media speculation over a potential bankruptcy filing led to a rapid tightening of trade terms just as the company was trying to build inventory ahead of the holiday season.  Here are the details:

1.  Debt - Apparently spending the majority of your FCF on debt service while ignoring capital improvements and store remodels is a bad long-term business strategy for a bricks-and-mortar retailer.

Toys “R” Us, however, has been operating for more than a decade with significant leverage, necessitating the use of substantial amounts of cash each year (approximately $400 million) to service the more than $5.0 billion of funded indebtedness.  But these substantial debt service obligations impair the Company’s ability to invest in its business and future.  As a result, the Company has fallen behind some of its primary competitors on various fronts, including with regard to general upkeep and the condition of our stores, our inability to provide expedited shipping options, and our lack of a subscription-based delivery service.

2. Vendors - Media speculation of an imminent bankruptcy filing starting on September 6th caused 40% of vendors to restrict shipments and demand "cash on delivery" for new inventory purchases which would have required $1 billion incremental liquidity.

More recently, the Company’s need for a comprehensive solution to its capital structure issues caused widespread “bankruptcy” speculation in the media, leading to a severe constriction in the Company’s trade terms.  More specifically, in late July the Company hired Kirkland & Ellis LLP and Alvarez & Marsal North America, LLC, complementing its retention of Lazard, to consider restructuring and capital structure solutions.

 

A news story published on September 6, 2017, reporting that the Debtors were considering a chapter 11 filing, started a dangerous game of dominos: within a week of its publication, nearly 40 percent of the Company’s domestic and international product vendors refused to ship product without cash on delivery, cash in advance, or, in some cases, payment of all outstanding obligations.  Further, many of the credit insurers and factoring parties that support critical Toys “R” Us vendors withdrew support.  Given the Company’s historic average of 60-day trade terms, payment of cash on delivery would require the Debtors to immediately obtain a significant amount—over $1.0 billion—of new liquidity.

3.  Holiday Inventory Build - Finally, this all came at the exact moment that the company was trying to build inventory for the holiday selling season.

The timing of all of this could not have been worse, as the Company is in the process of building holiday inventory.  While birthdays, new game releases, and other special events drive year-round sales, the holiday season is the most important for annual results.  In the fourth quarter (the weeks prior to Christmas), the Company generates approximately 40% of its annual revenue.

 

To prepare for the holiday season, Toys “R” Us significantly increases inventory in September to fill store shelves with the selection and variety of products our customers expect.  Accordingly, I believe it is critical that the Company reopen its supply chain immediately to ensure a successful holiday season.

Toy

 

Given that, it's somewhat ironic that Bloomberg notes this morning how important Toys "R" Us is to vendors and how Mattel and Hasbro couldn't possibly allow the company to liquidate.

Rest easy, kids. Toys “R” Us Inc. isn’t going anywhere, at least not if the makers of Barbie and Transformers have their way.

 

Yet, the company, which operates about 1,600 stores globally, will likely survive because manufacturers such as Mattel Inc., Hasbro Inc. and closely held MGA Entertainment Inc. need the last remaining toy chain. These vendors are eager for whatever remaining leverage they have against the might of Amazon and Wal-Mart, the bane of all companies focused on a single category of shopping.

 

“Oh my God, they are very important, and people don’t understand,” Isaac Larian, founder and chief executive officer of MGA, said of the toy chain. “That’s the only place where kids can go and just buy toys. There is no toy business without Toys ‘R’ Us.”

 

In many respects, suppliers have been propping up Toys “R” Us for years, according to Moody’s Corp. analyst Charlie O’Shea; they give the chain exclusive products during the holidays and funds for promotions to help it compete with the general merchandisers. The manufacturers offer this support because they want a place to sell toys at full price, year round. Major brands have also been funding an overhaul of Toys “R” Us stores by adding more featured areas for top brands such as Mattel’s American Girl dolls.

 

In the toy business, the incentive is particularly powerful. Last year, Toys “R” Us accounted for 11 percent of sales at Mattel and 9 percent at Hasbro -- the second most at both companies after Wal-Mart.

Meanwhile, many have speculated this week over how/why TOY bonds traded off 75 points on the company's filing?  How could they be so wrong?  While the timing of the filing was probably somewhat of a surprise, we can't help but wonder whether this simplistic org structure might have contributed in some small way?

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
venturen's picture

quicker story....private equity owners want to screw people out of pension, medical and wages....and other creditors...and this is the quickest way!

ParkAveFlasher's picture

To your point, the organizational structure is a defensive measure to deal with taxes, etc.  Many large corporations have Byzantine tax structures.

This bankruptcy likely has everything to do with that big ol' Bain Capital sitting up there at the top...

...and just a little bit of the Amazon Effect.

ejmoosa's picture

The better story is that this has happened with historically low interest rates.

Who's next?

RAT005's picture

Deep in the footnotes.....~1,000 USA stores, ~50 employees per store, Obamacare healthcare premiums up ~$2,000/yr/employee since its inception.  I wonder what $100million/yr for the last 5 years added back to the bottom line would do for them?

Cognitive Dissonance's picture

So instead of a run on the bank fueled by rumor, we had a run on Toys R Us's credit facilities? LOL

MrSteve's picture

Will we see the same scenario for other Christmas and/or seasonal sales-focused outlets? Apparently movie theater seat buyers are also on strike. Sears/KMart, Radio Shack, Toys Were US- a chapter in US cultural history is closing along with these firms.

Herp and Derp's picture

It would be great if the movies were worth seeing.  The local to Seattle theater chains (not owned by the film festivals/coops) have taken Chinese money and upgraded to electronic reclining chairs and serve beer.  They are cold as heck though because you and maybe one or two couples at most will be the only people in the theater.

El Oregonian's picture

A "Plop, Plop, Fizz, Fizz" moment. But there will not be a relief ending to this story. Much more (other retailers) to follow...

847328_3527's picture

"Change you can believe in" took another toll.

 

Toys-R-Us, may you RIP.

Occident Mortal's picture

My guess is that this is a good old fashioned corporate raid by the nice folks at Bain Capital.

 

There must be a good reason why they didn't do this nearer to xmas, when they could have extracted maximum panic / leverage.

Dammit Walter's picture

The demand for toys will likely flow to Walmart, Target, and Amazon.  Because kids need to add to their collection of 27 different kinds of nerf guns by each family member at xmas.

847328_3527's picture

Those Al Sharpton action figures with the purple Escalades sold pretty good but the talking Maxine water dolls did poorly. Too much cursing, even for black kids.

Common_Cents22's picture

People still go to movie theaters????

If you haven't looked into home theater projectors, you should.   They are incredible "value" compared to large flat screen TV or movie theaters.   HD 1080P for a few hundred bucks and you can get a huge screen projection, 90-150in diag.    All in the comfort of your own home.

4K (interpolated, not native yet) projectors are now getting to $2,000 price point.

Couple that with the various streaming services, and even Free KODI add-ons that have moves in HD that are still in the theaters.

justin423's picture

You are joking right? The premium increases in the prior 5 years was 2X that. Look at their 2002 versus their 2008 quarterly reports.

the late idi armin's picture

low interest rates might be why.

Dammit Walter's picture

Exactly!  Any company that took on debt at relatively high interest rates of 80s, 90s, 2000s, must pay a larger portion of their profit to service the debt, than folks that get lower interest rate loans at todays near zero financing rates.   That puts you at a disadvantage, because that money could go to improving the store or hiring more employees, giving raises (Ha!) and retaining good employees, expanding into other areas, marketing, etc, etc.  Especially when competing against Amazon which avoids the cost of a brick store, and has access to the same suppliers that you do.  Lower cost tends to supercede most other differentiators.  Online retailers are eating into B&M to the point where business forecast is flurries of Closures and Bankruptcies for the foreseable future.  (Not that this is a good thing... just the current reality)

new game's picture

collateral became impaired with too much leveraged debt at uber low interest rates.

sound familiar? and those pensions with uber low returns. fuking nightmare rolling accross the fruited plains.

a special thanks to goldmans sac of shit, da fed, and wall street co conspirators ie. the deep state of club, da club...

SSM

sickavme's picture

"the Toys "R" Us jingle in a court filing"

 

Well....

 

That pretty much explains why they went bankrupt: They... Are... Retarded....

bkwaz4's picture

They need to pay me the $800 an hour and I wouldn't get the lyrics wrong.

I distinctly remember: "I don't wanna grow up, cause baby if I did" ...

And I went there a lot in the 90's.  The mega zords are in the back.

Stuck on Zero's picture

It's unbelievable how many companies run at a loss ... burning capital to sustain operations. I regularly receive credit card offers that promise $1500 cash back for puchases of $3000 in the first year. What kind of business is that?  Is capital so cheap that people can flush it down the toilet?

RAT005's picture

I wanted to provide the link but can't find it.  News story of 500euro notes clogging up sewar pipes somewhere.

slwsnowman40's picture

You'll pay them way more than that $1500 in interest charges on the $3000 to make up the difference.

dussasr's picture

Last Christmas I purchased severl of my kids toys from Amazon.  Will likely do the same this year.

YUNOSELL's picture

No one wants their toys anymore?

Wrenching Away's picture

Kids don't want toys anymore, just the latest iPhone.

tmosley's picture

If you have to run a company on credit, you probably shouldn't be running it at all.

1stepcloser's picture

Same goes for Governments

twh99's picture

Not necessarily true.  If you have the proper cash flow, then credit can be a help.  In their case they didn't have the proper cash flow.

What really screwed them was their excessive debt and loss of confidence by their vendors.

Given the same conditions many many public companies could find themselves in the same boat.

MrSteve's picture

And what listed firm hasn't borrowed bigly for stock buybacks and C-suite options jackpots? Shrinking the share count just like shrinking the product packaging is the opposite of how firms grow. As the economy loses purchasing power, debt will only become more of a crush on cash flow, same as in any recession. The credit contraction impulse from the FED via bond rollover shutdown may be enough to trigger a panic, like rumors TOY was going Chapter 11 shut off vendor credit. Full faith has been broken in the USA credit structure.

Rockatanski's picture

i think you missed his point. he's isnt saying you can't have a credit card or even a line of credit.

its more like you should not need them to survive.

balancing cash flow, margin, inventory, etc is quite a balancing act if your margins are too low.

tmosley's picture

ToysRUs went private via a leveraged buyout. They have been a dead store walking since 2005. ObummerCare probably put the last nail in the coffin, as some handsome poster above mentioned.

Well, that plus the outdated business model. They were the "expensive" toy store. Everyone else gets their toys from Walmart and Amazon. If they buy toys at all. Kids these days have their eyes glued to portable devices (which is TERRIBLE for their developing eyes, by the way).

BlindMonkey's picture

One wonders when the State of Illinois is going to be put on a COD program since they aren't paying vendors either.  The outstanding tab is around $13-15 Billion or so.

the late idi armin's picture

Because most of those vendors exist to sell stuff to the state. So if you stop Springfield from putting  goods on the tab then your out of business.

 

 

MattPSU02's picture

There are large and stable companies that have a horrible reputation for payment on time, like IBM.  They just get away with it because vendors don't want to walk away from a business opportunity.  

NoWayJose's picture

I am baffled why these retailers load up on debt - store ownership is a horrible model (ask Sears). Much cheaper to license your name to someone else who will lease storefront space. Then supply the licensee with your products. Any retailer in the 'we own our own stores' space is going to go under.

mkkby's picture

Overpriced crap nobody wants might have something to do with it. In case you haven't noticed, kids play video games at an early age. Even as a kid I didn't like the junk in those stores.

A robot that turns into a building. I don't get it. What's fun about that?

Buy your kid a bat, softball, basketball, soccer ball. Last forever and promote good health. No electronic shit that makes them fat and stupid, and doesn't last as long as the credit car bill.

lucyvp's picture

Problem is you can't buy the bat, ball, truck, etc at toys-r-us.

I have kids and tried.  Some accountant took over merchandising in the 2000's and the store was heavily tilted toward high margin crappy toys that are fascinating for a few hours then abandoned, then I throw them away the following year.  

Simple toys last a life time.  Simple toy trucks, cars, balls, bats.  Inexpensive and due to their simple nature it is the mind that can decide how they are to be used.  Electronic do-dads are so sophisticated/dedicated it can only be used one way.  

I stopped going to toys-r-us 12 years ago.

tmosley's picture

>A robot that turns into a building. I don't get it. What's fun about that?

Was that meant to be a quote from "Big"? Because I'm pretty sure that was a quote from "Big".

migra's picture

If you have a great product store ownership is a good way to protect the brand. Starbucks comes to mind. Selling an addictive product with them owning the vast majority of stores is a great way to control quality. At the same time their error has been pissing off millions of current and potenial customers with their out spoken left wing political postions. 

bitplayer's picture

Starbucks has a great product?

CRM114's picture

The coffee is not the product, the 'lifestyle' is.

And by 'great', he means 'profitable'. Do not think of comparing it with anything that has intrinsic artistic, scientific or moral value.

justin423's picture

Um, the retailer didn't load up on debt.
Bain Capital did and this was inevitablly going to happen since 2005.
I don't think any leveraged buyout of a retailer has ended any differently.
I guess Staples is next.
Why anybody buys the debt is beyond me.

buzzsaw99's picture

uh, because the private owners took huge bonuses every year?

 

hey! how'd you make out today?  [/billy ray valentine]

The Ram's picture

Creative Financial Destruction.   

buzzsaw99's picture

you can't make an LBO bonus omelet without breaking a few sad egg bondholders.

rockstone's picture

It appears to be yet another case of running out of other people's money.

I do like this guy's attitude though;

“Oh my God, they are very important, and people don’t understand,” Isaac Larian, founder and chief executive officer of MGA, said of the toy chain. “That’s the only place where kids can go and just buy toys. There is no toy business without Toys ‘R’ Us."

Nice way to hustle for that bail out. "It's for the children! My God, have you no compassion?"

Nope....

CRM114's picture

Exactly.

Effectively mortgaged the company up to the hilt. Put suppliers on 60 day credit.

Put themselves on a pedestal. It fell over.

Sympathy? You will find it in the dictionary between sh!t and syphillis.

Dear Stock/Bondholders, the senior management doesn't just not give a f#ck about customers and employees, they don't give a f#ck about you either.