Brick-and-Mortar Meltdown: Toys “R” Us after Bankruptcy?

by Wolf Richter, Wolf Street:

It can’t solve what is killing it.

Bankruptcy indicators first started swirling publicly around Toys “R” Us on September 6. Unlike other retailers that have been dogged by bankruptcy rumors for years, such as Sears Holdings, Toys “R” Us threw in the towel only 12 days later, when its suppliers, fearing steep losses, reacted just as the company was trying to build its inventory before the crucial holiday sales period.

It wasn’t bondholders or banks that pulled the ripcord, but trade creditors. The US and Canadian entities filed for bankruptcy protection in order to be able to restructure their debts and stock up for the holidays with a proposed $3.1 billion in debtor-in-possession (DIP) financing.

TRU’s overall sales and same-store sales have been declining, even as the toy industry has seen growing sales for five years in a row, hitting $20.4 billion in 2016, up from $16 billion in 2012. It’s respectable growth of around 5% a year. But TRU is getting clobbered by its competitors, including Walmart and Target, and particularly by the relentless shift to online shopping.

About 31% of all toy sales are now online, according to the Toy Association. In some key categories, the percentage is higher: video games (39%), apps (38%), and electronics (33%).

TRU is buckling under $5.2 billion in debt that its private-equity owners – Bain Capital, Kohlberg Kravis Roberts, and Vornado Realty Trust – piled on it after the leveraged buyout in 2005, and it did not invest sufficiently in creating a powerful online presence able to beat Amazon off its territory.

“But the immediate cause of the Chapter 11 filing was a crisis of confidence on the part of the company’s trade vendors, which historically has been a risk for retailers, particularly as they build inventory levels for the holiday season,” explained Stephen Selbst, chair of the law firm, Herrick’s Restructuring & Bankruptcy Group.

And when bankruptcy indicators became public, it happened fast. Selbst:

According to the company, the reaction among the vendor community was swift and brutal: within a week nearly 40% of its trade vendors put the company on COD status and many factors and credit insurers withdrew support. Prior to this crisis, Toys “R” Us had experienced an historic average of 60 days of trade credit support; the new terms would have required an immediate infusion of up to $1 billion in new cash, money that Toys “R” Us neither had nor could obtain.

Trade financing will likely be resolved with the proposed $3.1 billion in DIP financing. The longer-term problems are not so easily solved:

In papers filed with the Bankruptcy Court, Toys “R” Us chief executive David Brandon admitted that the debt service obligations have harmed company’s ability to compete: “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 failed to capitalize on the iconic Toys “R” Us brand and its unique position as a one-stop shop for toys every day year round.”

The Chapter 11 filing did not mention any additional store closings, shrinking its footprint, withdrawing from unprofitable markets, or selling or liquidating its business. Instead, it wants to use the DIP financing to improve its stores and operations. But Selbst explains:

[N]early all retailers that file for bankruptcy end up closing stores, in part because Chapter 11 gives management the opportunity to reject leases for unprofitable stores. Given the large number of stores Toys “R” Us operates, it is likely that there are some weak performers in the mix, so it is probable that Toys “R” Us will shrink its U.S. and Canadian footprint while in bankruptcy.

 

Debtors are often unrealistically optimistic at the start of their bankruptcy cases about what they can achieve in Chapter 11 and the level of goodwill they have banked with their creditors. The long experience of retailers in Chapter 11 suggests that very few of them are able to reorganize; most liquidate or are sold in bankruptcy.

Numerous retailers that filed for Chapter 11 bankruptcy to restructure their debts and operations ended up liquidating. And a number of retailers that successfully emerged from bankruptcy ended up filing for bankruptcy a second time, which usually ends in liquidation. Here’s a recent sampling:

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