Once the jingle on everyone’s mind, today’s ancient history. Following the path of other well-known retail brands such as Claire’s, Payless, or Sears, in 2017 Toys “R” Us filed for bankruptcy in what some have been calling a retail apocalypse. But what do these retailers have in common with Toys “R” Us? Well, it is a fact that most of them were owned by private equity firms, which acquired them through high-leverage transactions. But was this the reason that led the largest toy retailer in the U.S to bankruptcy?
Long gone were the days of triumph for Toys “R” Us. Despite its impressive performance in the ’90s, achieved through a loyal customer base, the early ’00s signaled a new challenge for the company: the proliferation of low-priced competitors.
In 2005, following the late unfavourable industry trends, the disastrous decisions regarding its online channels and the lack of strategic vision of the management, Toys “R” Us initiated a turnaround plan that ended with the chain being acquired and taken private by Bain Capital, Kohlberg Kravis Roberts and Vornado Realty Trust in a $6.6 billion leveraged buyout (LBO).
To the private equity consortium, Toys “R” Us appeared to be a good LBO candidate: the stable and predictable revenues, the efficiency enhancement opportunities, and its leading position in the market was seen as sufficient to repay the borrowed money. In addition, Toys “R” Us was also the owner of several real estate properties, which certified the deal with extra security and enabled management to indebt the firm in $5.5 billion.
Bought at a full purchase price and with little margin for strategic errors, the following years were crucial for a well-succeeded transaction. However, after the 2008 crisis, the operational and financial challenges faced by the company became more evident as the expected improvements were not reached. It would be more intuitive to solely blame the complex, highly leveraged capital structure for Toys “R” Us’ downfall, but the continuous technological disruption that encouraged the evolution of shoppers’ preferences is also a big responsibility.
Toys “R” Us failed to comprehend and adapt to the cultural revolution, continuing to operate using an obsolete product mix. The financial crisis crushed retail companies by forcing consumers to cut back on their spending, especially for less necessary items. While other companies developed technology and spread it into toys field in order to respond to the clear rise in demand for electronic devices, Toys “R” Us’ operating flexibility was limited by large debt payments. Moreover, in the age of internet retailing, Toys “R” Us outsourced their e-commerce business to Amazon early on, in an imprudent deal that gave Amazon tremendous insight on Toys “R” Us customers and retrieved nothing.
In addition, competition was also a prejudicial factor. The industry (and Toys “R” Us specifically) faced a challenging environment as a result of pressure from competitive big box retailers as well as a general market shift towards online shopping. Walmart, Target, and Amazon relied on price discounted toys to get parents to switch loyalties and consequently changed the retail paradigm towards more convenience, lower prices, and fast-paced purchases.
Lastly, Toys “R” Us’ indebted capital structure, a legacy of its 2005 leveraged buyout, did not allow the company to keep the debt burden low to face a possible downturn, as opposed to most retail firms.
To worsen the situation, the strong cash generation expected to pay the debt at the time of the leveraged buyout did not occur, as Toys “R” Us’ revenues remained rather stable. When, in 2017, lenders failed to agree on terms for a refinancing operation, certain covenants were breached, and a subsequent snow-ball effect occurred. This force was intensified by the unfortunate timing of the bankruptcy — the company’s suppliers stopped the shipment orders until some cash payment was made just before holiday sales, which proved to be disastrous. In an industry in which holiday returns are crucial, and gift cards are increasingly important, any reason for questioning a retailer’s future was enough to shop elsewhere, and consequently undermine the company’s performance.
It now seems that the reasons that led Toys “R” Us to bankruptcy were evident. But could it had been avoided?
For starters, selling a product as discretionary as toys means that in times of recession, there is a higher probability of being hit. Therefore, it is essential to have a manageable amount of debt, and this was not the case for Toys “R” Us. Nevertheless, even though the financial situation of the company was not as flexible as desired, the operational position could have been largely improved.
Had the firm not forgotten to deliver added-value and human interaction, offering personalized attention and hands-on experience while treating their stores like experience shops and making each visit a unique and worthwhile experience, the company could have had strategically fought the price-war with big-box retailers and the more convenient purchasing tools offered by the online channels.
Additionally, an original product line and a more automatized product-mix should have been developed, complemented by an effective in-store promotion that would have created purchasing opportunities due to the uniqueness of the product and the maximization of time spent in the store.
Lastly, it is known the key for traditional retail success continues to be an omnipresence approach since in-store and off-store purchases are both dependent on the company’s digital presence. The lack of online presence resulted in a dramatic absence of customer engagement, which could have been tackled with a more convenient website, social media presence, personalized content, and several other loyalty programs.
It is a case to say that the Toys “R” Us kids that did not want to grow were definitely forgotten.
Diana Gato graduated from the Master’s in Finance, at Nova SBE, in 2019. After having completed her Bachelor’s Degree in Economics at Faculdade de Economia do Porto, in 2017. Passionate about strategy, investment banking, private equity, and venture capital, she co-founded Nova Venture Capital and Private Equity Club, where she got the opportunity to put in practice numerous financial tools and soft skills. Professionally, after having completed a traineeship at the European Investment Fund in Luxembourg, she is currently working as a business developer at BBVA in Lisbon.