Facing Imminent Bankruptcy, Toys "R" Us Enters Death Spiral

Last week's news that Toys “R” Us has hired bankruptcy lawyers Kirkland & Ellis to help restructure its heavy debt load, came as a shock to the company's creditors, who promptly sent its bond crashing from nearly par at the start of the month to 43 cents on the dollar as of Friday.

As Bloomberg first reported, K&E is focused on the $400MM in bond due 2018, while Toys “R” Us has also retained Lazard to help with debt refinancing. They will have their hands full: in addition to shrinking sales and heightened competition, Toys ‘R’ Us has been burdened with debt from an LBO12 years ago as a result of which Toys “R” Us’s private equity owners, Bain Capital, KKR and Vornado Realty Trust, loaded up the company with $7.5 billion in debt.

Last year, the retailer extended maturities on some of borrowings, giving it more time to execute a turnaround plan by Chief Executive Officer Dave Brandon. As part of his comeback bid, he was looking to spruce up stores with more toy demonstrations and other experiences - seeking an edge on online sites such as Amazon. However, last week's realization that the company is considering a debt-for-equity exchange, confirmed many worst fears that not only was the turnaround faltering but that underlying business was far weaker than expected.

The imminent restructuring, which judging by the shocking bond crash was completely unexpected, would help Toys “R” Us get its house in order ahead of the all-important holiday season, when the company has its biggest sales surge. Alas, now that the iconic toy retailer appears likely to cramdown at least one if not more creditor classes in some form of pre-pack Chapter 11, said sales surge may not happen at all if the company's suppliers suddenly get cold feet and refuse to stock up the company with much needed inventory.

Which is precisely what is happening.

Making matters worse, according to the WSJ, Toys ‘R’ Us could file for bankruptcy as soon as next week, while Bloomberg adds that nervous suppliers have scaled back shipments and tightened terms to the retailer ahead of the crucial holiday selling season, on worries they may not got repaid and their payables would be lumped alongside other unsecured pre-petition claims. 

The vendors are balking as Toys “R” Us continues talks with lenders over a new loan that would allow the company to stay open while it works out a recovery plan through bankruptcy proceedings, said the people, who asked not to be identified because discussions are private. The loan is being marketed by Lazard Ltd. to banks and existing creditors, said one of the people. 

Just like in the case of Sears discussed here at the end of August, suppliers have pulled back in part because the cost to insure their shipments to cash-strapped Toys “R” Us has become too expensive, according to Bloomberg sources. Since vendors traditionally rank among other unsecured creditors under a bankruptcy waterfall schedule, their decision on whether to continue shipping goods can play a large role in determining a retailer’s fate.

Unfortunately for Toys “R” Us, now that it has entered the self-reinforcing death spiral of collapsing liquidity and panicked vendors, it needs to find a financial solution immediately and resume shipments because the cash-strapped chain makes about 40% of its sales during the fourth-quarter holiday season. Much of its strategy revolves around getting exclusive products from key vendors, along with support for advertising and marketing.

For now, the toy merchant has been seeking to refinance $400 million of debt that comes due next year, although media reports suggest that the process has stalled. As a result, the company is now openly flirting with bankruptcy as an option although no decision about seeking court protection has been made.

Still, as Bloomberg calculates, Toys “R” Us has remained oddly profitable, generating $790 million in EBITDA, the most since 2012, yet even that is not enough to appease vendors many of whom now demand payment upfront. Not everyone thought: Hasbro is among toymakers that hasn’t curtailed shipments, spokeswoman Julie Duffy wrote in an email. “We continue to partner and ship, conducting business as usual, while managing our risk across all retailers to the appropriate levels,” Duffy wrote.

Hasbro may regret this decision very soon as according to the the company's 5 Year CDS, which in recent days have soared to 46 points upfront...

... the probability of default in the next five years is now 93%, and 60% over the next 12 months.

A Toys ‘R’ Us restructuring would add to a list of 25 retailers, including Rue21, Gymboree and Payless Shoe Source, that have filed for bankruptcy since the beginning of 2017. Another big box chain, Staples Inc., recently agreed to be taken private in a leveraged buyout.

Source: @ReorgFirstDay

While industrywide, toy sales have been strong in recent years, much of the growth is shifting to online sellers like Amazon.com Inc. and discounters like Wal-Mart Stores Inc. Amazon’s toy sales were up 24% last year, compared with 5% for the overall market and five years of declines for Toys “R” Us, according to analytics firm One Click Retail.

The company is not alone as it finds it is woefully behind in its competition with Amazon: some large toy brands, such as Lego and Star Wars, have also struggled recently, while the collectible Shopkins toys, which Toys ‘R’ Us helped launch, is on the downswing. Earlier this month, Lego AS reported its first decline in sales in 13 years and said it would cut 8% of its workforce. Another toy maker, Mattel Inc., replaced its chief executive earlier this year after a slide in holiday sales.

Ultimately, whatever the fate of Toys 'R' Us may be, it will inevitably go through bankruptcy court: according to the WSJ, in recent weeks Toys ‘R’ Us’s advisers have been hunting for a DIP loan to fund operations under chapter 11, effectively guaranteeing that a bankruptcy filing is now just a matter of days.

Comments

GUS100CORRINA Mazzy Sat, 09/16/2017 - 14:35 Permalink

Toys "R" Us Enters Death Spiral: Facing Imminent Bankruptcy, Suppliers Halts ShipmentsObservation: Is this another casualty of the AMZAON effect?Between the Amazon effect and the DEMOGRAPHIC BOMB, toy companies and retailers will be facing tough times.By the way, America has slaughtered 60 million plus babies to date! Just think about how many toys those murdered children would have enjoyed?WELCOME TO YOUR NIGHTMARE AMERICA! Not only are toys sales in the tank, but GOD Almighty is ANGRY as well!!Reminds me of the sermon by Puritan Preacher Jonathan Edwards titled: SINNERS IN THE HANDS OF AN ANGRY GODhttp://www.jonathan-edwards.org/Sinners.pdfREAD IT IF YOU DARE!!!! It is on youtube as well.

In reply to by Mazzy

Mazzy Sat, 09/16/2017 - 14:28 Permalink

Toys R Us's main problem has always been price.  A friend and I took a peek in there a couple years ago and got sticker shock.  Even as an 8 year old I knew they were a little on the pricey side, but they have gotten prohibitive at this point.  If people can't afford your product you won't get sales.

Hugh Mann Sat, 09/16/2017 - 14:35 Permalink

If they sold things worth purchasing they wouldn't be going out of business. Unfortunately everything from automobiles to Tonka trucks has been turned into cheap, plastic shit. Nothing is being manufactured to last anymore. Everything has a designed life span. As a young boy, I had a few toy trucks made from metal that could probably stand the weight of a truck. Not anymore. Remember when refrigerator would last decades? Now you're lucky if you get five years out of one. Most retailers and speciality stores have become junk dealers. As someone else pointed out, most kids today would rather play a video game of tennis than actually go outside and play the real thing.

DemandSider Ms No Sat, 09/16/2017 - 16:39 Permalink

The door seal on the 5 year old, front load, $750.00, Mexican, Whirlpool washer my wife bought disintegrated, so rather than throw more good money after bad, I bought a 15 year old, top load, Speed Queen for $75.00 off of Craigslist. After replacing the dried out v-belt for $10.00, it has worked flawlessly for 2 years, so far, and the clothes don't smell like mildew, anymore. I  washed 2 deer hides in it last fall. (I tie flys). No problems, no smell.Same story for the $800.00, glass top stove she bought, after, oddly enough, the glass broke when she put a heavy pot of water on it. The heating element was then exposed, so it was pretty dangerous. Replaced with a mint condition, coiled heating element style stove for $75. The oven had never even been used. No problems. Every replacement part on the new/old stove is available, new, on eBay, "Buy it Now" price, for $20.00 or less. It would have been at least hundreds to buy and replace the glass for the "high tech", newer stove, which had hideous, brown stains on the glass even before shatteringThe "modern", $800.00, (yes, the wife, again) digital refrigerator will be next. It wrecked the drywall in our tuck under garage after the "frostless" freezer iced up and leaked melt water. I fixed it by wrapping a few cents worth of copper wire from the defrost heater element to the fins surrounding in the freezer. For $800.00, you'd think Wall Street brands would have the frost issue completely licked, by now, but, you would be sadly mistaken, All digital readouts are fried, and the ice maker stops working unexpectedly on occasion. As with every other case in this appliance tragedy triad, its old, heavy, predeessor worked fine for decades, only to be unceremoniously jettisoned for the latest in Mexican plastic and software.I give you "energy efficiency" in neoliberalized America. 

In reply to by Ms No