March 20, 2018

Toys 'R' Us Bankruptcy Moves onto Chapter 7 Liquidation. Once again, history repeats itself with disastrous private equity firm ownership.

Toys 'R' Us Chapter 7 Bankruptcy.

The once-storied American toy store Toys 'R' Us declared Chapter 7 liquidation bankruptcy last week.  Today is the company's first hearing in Bankruptcy Court, where Toys 'R' Us will attempt to defend its bankruptcy plan from a hurricane force list of objections from creditors.  The top three unsecured creditors are reportedly Bank of New York (owed $206.3 million), followed by Mattel (owed $135.6 million), and Hasbro (owed $59 million).

Heck, Toys 'R' Us was even brazen (or dumb) enough to open a brand new store near me in Concord, CA ... in late October 2017, shortly after declaring Chapter 11 bankruptcy.  And the brand new Concord, CA Veranda Mall where the store opened was just as inept to allow a store in Chapter 11 Bankruptcy to move in as a prime tenant.

I forecasted Chapter 7 Liquidation Bankruptcy for Toys 'R' Us last year, after the company declared Chapter 11 Reorganization Bankruptcy; my September 20, 2017 blog post is pasted below.  And I didn't need a crystal ball to forecast the Toys 'R' Us Chapter 7 Bankruptcy, either.
" ... I just don't see Toys 'R' us staying away from a future Chapter 7 liquidation bankruptcy."   -- Mary Rae Fouts; September 20, 2017
What happened?  Well, history simply repeated itself.  Once again, nothing much good happened to public company - in this case, Toys 'R' Us - after it was taken private by a private equity company and a real estate trust.

For background on the all-but-certain-to-happen demise of Toy 'R' Us, read my blog post from September 20, 2017 below.
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Did competition in the toy industry drive Toys 'R' Us into Chapter 11 bankruptcy, or was the main culprit something else?

Sure, toy industry competition play a part.  But I think the main culprit was something else.

And that something else is private equity firm ownership.

Contrary to some people's belief that Toys 'R' Us is a publicly-traded company, it is privately held by an investment group consisting of private equity firms.  Toy 'R' Us was a publicly traded company from 1978 through 2005, when an investment group (Bain Capital Partners LLC, Kohlberg Kravis Roberts & Co., and real estate investment firm Vornado Realty Trust) took the company private by purchasing it for $6.6 billion.

Notice the purchase participation of a real estate investment firm?  Much of Toys 'R' Us' acquisition was based not on the chain's store operations and sales, but rather on the value of the company's real estate.

What has happened to Toys 'R' Us since then?  Not a lot of good.

Since Monday's Chapter 11 (reorganization) bankruptcy, the company has been very careful with its selection of words to explain its actions.  It has stated it "expects" to continue honoring warranties, return policies, and gift cards.  Expects?  Expects is not a very comforting word for those on the other end of a bankruptcy proceeding, including the company's 60,000 plus employees.

And about those employees, they have previously been given the middle finger by Toys 'R' Us' private equity owners.  Heck, 2 years ago, 67 New Jersey based Toys 'R' Us employees, skilled employees who worked primarily in the company's accounting division, were fired and replaced by imported workers from India using H-1B Visas.  To add to the indignity of being fired, the New Jersey based Toys 'R' Us accountants  were forced to train their Indian replacements before being shown the door.  Read about this crass stick-it-to-loyal-employees move in this New York Times article.

And I concur with analysts who have deep concerns about the future viability of Toys 'R' Us.  The company is drowning in a whopping $5 billion in acquisition-related debt.  Much of this debt obligation was due payable this year, which likely helped triggered the Chapter 11 bankruptcy filing.  Then, of course, there is the hyper online and brick and mortar competition in the toy industry.  With that combination of factors, I just don't see Toys 'R' us staying away from a future Chapter 7 liquidation bankruptcy.

Toy manufactures seem to concur, too.  They are demanding cash payment up front ... cash, baby, cash ... before shipping any toys to Toys 'R' Us.  This demand recently required Toys 'R' Us to secure $1 billion in financing for pre-payment of toy orders.  And with the upcoming holiday season, this prepayment demand debt is only going to get worse.

Is the Toys 'R' Us situation unique?  Nope.  Similar situation happened to the former San Francisco Bay Area based clothing chain Mervyn's.  Mervyn's was taken private when it was acquired by a group of private investment firms including Sun Capital Partners, Cerberus Capital Management, and real estate investment firm Lubert-Adler Management.  But you see, the investment group didn't purchase Mervyn's based on the company's store operations and sales, but rather for the value of Mervyn's real estate portfolio.

Yep, for the value of the Mervyn's buildings.  Notice the similarity to the Toys 'R' Us privatization?

And what happened?  You guessed it.  A mere 4 years later, Mervyn's filed for Chapter 11 bankruptcy, followed by full liquidation through a Chapter 7 bankruptcy.

Mervyn's.  Toys 'R' Us.  Equity firm ownership.  Value of company's real estate.  Sounding familiar?

Ah, history.  Those who fail to learn from history are doomed to repeat it.

About Mary Rae Fouts, EA

Mary Rae Fouts, EA provides tax, insurance consulting, and expert witness services to clients who have technical or complex concerns.  For more information visit

Mary Rae Fouts

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