This column has been updated.
For anyone who grew up in the ’70s or ’80s, Toys R Us was a sort of a magic kingdom, like a candy store in its powers to enchant. So many aisles of delightful things to play with. You could wander there for hours, and many of us did just that.
Alas, some magic is going out of the world. The venerable retailer, already in bankruptcy, is expected to tell the court Monday that it can’t figure out a way to reorganize as a going concern and must therefore begin the process of an orderly liquidation. Which in finance-speak means shutting down stores, selling off everything that can be sold and handing the proceeds over to creditors.
On Friday, Hasbro was down 2 percent, while Mattel investors were reeling from a 7 percent decline in the value of their holdings. And no surprise. One analyst, Stephanie Wissink of Jefferies, thinks that with no more Toys R Us, 10 percent to 15 percent of the firm’s sales could simply not happen anymore. Since the company accounts for roughly 17 percent of the U.S. market, that translates into a 1.7 percent to 2.5 percent decline in overall toy purchases, in a market that grew only 1 percent last year.
But wait. If Toys R Us is going to have such a meaningful effect on overall toy sales, doesn’t that suggest that it’s still, you know, selling a lot of toys? Toys aren’t exactly buggy whips — there’s still a market for them (about $20.7 billion worth of sales in 2017). And Toys R Us seems to command a healthy slice of that market. So why can’t it be saved?
Good question. It turns out that, as with many failures, the answer is a combination of “bad planning” and “bad luck.”
Toys R Us has the problems you’d expect from a big-box retailer in the Age of Amazon. It also has some problems of its own making, notably the large amount of debt it took on during a 2005 leveraged buyout. When the company goes down, you can expect to hear a lot of accounts blaming bad management and greedy bankers. And sure, go ahead and blame them. But don’t be too hard on them. But for a little bad timing, they might well have gotten away with it.
We like to tell ourselves morality plays about failure. Someone is either a victim or a villain, and which is which varies by, among other things, ideology. During the financial crisis, for example, you got two starkly different accounts of the people who got caught short by the housing bubble; conservatives saw them as gamblers who deserved what they got, while liberals thought they must have been rooked by Wall Street.
In fact, if you interviewed those folks, you generally found that they were well aware that they couldn’t really afford their house if the payment reset. They just expected to be able to refinance it when prices climbed, or they got a raise, or at worst, to sell if they couldn’t afford the payments. Then prices collapsed, and they ended up in a whole world of trouble.
What they did was undoubtedly risky. But plenty of people took that exact same risk in 2001 — buying more house than they could afford. But those people had no trouble refinancing to more affordable mortgages, because the market was soaring and they had loads of equity. The same risk produced two very different outcomes depending on when people happened to take it.
You’ll see this pattern repeated over and over if you look at failures, from major disasters to corporate collapses: They start with people taking risks that others (or they themselves) had taken before. Only this time, something goes wrong, and that little risk turns into a big problem.
And so with Toys R Us. A leveraged buyout significantly increases a company’s risk, because larding the company up with a lot of debt divides its finances into a stark binary: Either it has enough to make its debt payments as they fall due, or it doesn’t. If it’s on the wrong side of that divide, bankruptcy quickly looms.
But Safeway and Hilton, to name just two companies, are still going strong despite having gone through an LBO. And at the time, the Toys R Us must have seemed like a pretty reasonable bet. After all, the company was a category killer in a category with strong demographic potential, given that the tail end of the baby boom was just finishing up its childbearing years and entering the peak earning period when parents have money to lavish on children — a great time to earn the money needed to reduce that debt, take the company public and exit gracefully.
They couldn’t have foreseen that within three years, the country would be in the throes of the worst financial crisis in generations, that the stock market would crash, incomes would stagnate and, worst of all, people would put off having children. Nor could they have predicted, in 2005, that Amazon would come to be as dominant as it did. Or the Internet more generally — online distribution of video games, for example, has devastated a once-lucrative bricks-and-mortar business.
It seems clear that if it hadn’t been for the LBO, Toys R Us would still be around (for a while, anyway). But that might well be true if only it had done that deal just a little bit earlier — early enough to let it pay down some of that debt. As the Bible says, “time and chance happen to us all.” It’s just that when you take a lot of risk, they tend to happen faster and harder.