Toys ‘R’ Us Needs to Up its Game for Owners to Cash Out

Toys ‘R’ Us Needs to Up its Game for Owners to Cash Out

If Toys ‘R’ Us' private owners hope to eventually sell the toy store chain, retail consultants say they have to become more proactive about improving the retailer’s performance to contend with discount stores and online competitors.

Private equity players Bain Capital and Kohlberg Kravis Roberts (KKR) and diversified REIT Vornado Realty Trust have owned Toys ‘R’ Us since 2005. The owners had been plotting an IPO for two years as an exit strategy before reversing course in March after realizing the retailer’s performance was too underwhelming to achieve a good valuation. Bain, KKR and Vornado purchased Toys ‘R’ Us in July 2005 for $6.6 billion. Their first misstep was paying too much for the chain, according to Howard Davidowitz, chairman of Davidowitz & Associates Inc., a New York City-based retail consulting and investment banking firm. With the $5.3 billion in debt that Toys ‘R’ Us now carries as a result of the leveraged buyout it will be difficult to dispose of the company without taking a loss. Unlike many other retailers that had been bought in the mid-2000s, Toys ‘R’ Us doesn’t have real estate assets to fall back on—it leases most of its stores.

Plus, “the [public] market has improved somewhat since 2008-2009, but it’s still not great,” says Geno Coradini, executive vice president and retail lead for Texas/Southwest with Jones Lang LaSalle Retail. “There is still some uncertainty today, so depending on your capital needs, you may want to [wait for an IPO] until the market has greater confidence in the economy.”

The timing of the buyout hurt, and not just because of the Great Recession, notes Doug Stephens, head of consulting firm Retail Prophet. Toys ‘R’ Us rose to prominence as baby boomers began to have children, he points out. The current crop of new parents, the much smaller generation X, can’t possibly provide the retailer with the same volume of customers as it had before.

Combine that with Wal-Mart Stores Inc’s and Target’s aggressive expansion into the toy category and with Amazon’s emergence as the go-to online sales channels for all sorts of merchandise and Toys ‘R’ Us finds itself in an increasingly vulnerable spot. It sells the same products as a host of other retailers and does so at higher price points, according to Davidowitz.

For the fourth quarter of 2012, ended Feb. 2, Toys ‘R’ Us reported that its U.S. same-store sales declined 4.5 percent, while international sales fell 5.4 percent. For the full fiscal year, domestic sales fell 3.5 percent and international sales fell 5.0 percent.

“When I did work for them [20 years ago], they had 28 percent of the toy market,” Davidowitz says. “Now they are down to 16 percent. Why did that happen? Because Wal-Mart and Target have been building stores like crazy and increasing their online efforts and sharpening their prices.”“Going public is off the table for years—they have negative sales, they have too much debt and there is no growth in the toy industry.”

Hope remains

Toys ‘R’ Us does have some advantages over its peers in other big-box categories because it is the only major bricks-and-mortar specialty toy retailer in the market and because its brand name still holds some caché, according to Stephens.

That means that its owners can try to sell it to another private equity player if they are willing to offer it at a low enough price, says Davidowitz. He notes that Apollo Management L.P. has previously expressed interest in the retailer and might be willing to look at it once again.

“If you sell at a low price, you can fix it and that is one way to fix the problem with the over-leverage, but they all might take a gigantic haircut,” he says of Bain, KKR and Vornado.

Toys ‘R’ Us’ established position in the specialty bricks-and-mortar world also means that it still has the opportunity to right itself if it takes effective measures to improve its online experience and becomes more competitive on pricing. The chain does have an online sales channel, but so far it hasn’t been too proactive about promoting online shopping during the winter holidays or around its customers’ birthdays, according to Stephens. It needs to make its website more community-based and more exciting in order to combat Amazon’s convenience and low pricing, he says.

The chain’s management also has to work on better product assortment and lower prices at the bricks-and-mortar stores, adds Davidowitz. The bottom line is that it can’t keep doing the same thing it always has or it risks ending up in a position similar to Best Buy’s.

As of February, Toys ‘R’ Us operated 1,540 stores in 36 countries, including 875 stores in the United States.

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