When Toys R Us announced Thursday it would be closing or selling all of its 800 U.S. stores, analysts offered many reasons for the company’s demise: stale stores, a hard-to-navigate website and increasing competition from the likes of Walmart, Target and online retailers.
But perhaps it encountered its biggest challenge, bankruptcy lawyers and retail experts say, when two private-equity firms and a real estate investment trust bought the company in 2005 as part of a leveraged buyout and took it private. In the process, they loaded the toy store chain with roughly $5 billion in debt.
“It was a heavy load that was ultimately too much to overcome, especially as they began to fall behind in other ways,” said Jim Silver, chief executive of the toy review website TTPM. “They had solid results, but not the kind of substantial growth necessary to carry that kind of debt.”
Ever since, the company has struggled to repay the debt, handing over $400 million a year, often at the expense of turning a profit. Recently, it had begun burning through $50 million to $100 million in cash each month as it tried to dig its way out, according to court documents filed Thursday. Toys R Us is owned by three companies — the private-equity firms Kohlberg Kravis Roberts and Bain Capital, and the real estate firm Vornado Realty Trust. The firms did not immediately respond to calls and emails seeking comment.
The big-box chain is just the latest example of a private-equity-backed retailer that is paying the price for debt-laden deals dating back years, if not decades. Among those that have recently filed for bankruptcy are Gymboree, BCBG Max Azria, Limited Stores, Rue21, Sports Authority and Wet Seal, all of which had large debt loads.
Also on Thursday, iHeartMedia, the country’s largest radio company — purchased 10 years ago in a leveraged buyout by Bain Capital — filed for bankruptcy, citing $20 billion in debt.
“Those deals might have made sense at the time, but the world has evolved,” said Philip Emma, an analyst for Debtwire. “Toys R Us . . . [was] part of that wave of retailers that went private at the peak of the market. The real estate market was hot, sales were booming and the housing market was taking off. But all of those things have since come crashing down in various ways.”
Perhaps the first domino to fall, analysts say, was the department store chain Mervyn’s, which went out of business and closed all of its stores in 2008, just four years after it was purchased by a group of investors including private-equity firms Sun Capital Partners and Cerberus Capital Management. (In 2012, the firms agreed to pay $166 million to Mervyn’s creditors to settle a lawsuit alleging that the private-equity companies fraudulently profited from the retailer’s demise.)
A year later, KB Toys — which was also purchased in a leveraged buyout by Bain Capital — closed all of its stores after two bankruptcy filings. A number of other retailers, including Linens N Things and Steve & Barry’s, also had a similar fate.
“It’s a perfect storm that’s led to one bankruptcy after another,” said Craig Barbarosh, an attorney at Katten Muchin Rosenman who specializes in corporate bankruptcies. “These deals from that era were made under extremely aggressive — perhaps not even realistic — assumption, and that’s what we’re seeing again with Toys R Us.”
In 2005, though, executives were hopeful that the Toys R Us’s new owners would help breathe life into the childhood staple that spanned generations, which was just beginning to deal with increased competition from Walmart and its rivals.
“These new owners have embraced our strategy,” John H. Eyler Jr., the company’s chief executive at the time, told The Washington Post in 2005. “Toys R Us is going to be around for a long time.” (Eyler received $65.3 million on the completion of the deal.)
But analysts say Toys R Us did little to reverse its fortunes. It continued to lose customers to big-box chains that promised lower prices and more convenience, as well as to neighborhood boutiques where children could get personalized attention and hands-on experience.
“There has been no strategy at Toys R Us,” Silver said. “They talked about making stores smaller, about making them bigger, about adding more experiences, or combining toys with Babies R Us. But nobody ever had a plan to make it work.”