Toys ‘R’ Us: Victim of Poor Management Decisions?

November 1, 2017

Just two weeks after filing for bankruptcy protection, Toys ‘R’ Us is debuting an augmented reality experience that it hopes will drive traffic to its stores and away from online retailers. The Company’s strategic change is an attempt to capitalize on the recent Pokémon Go craze, making shopping at Toys ‘R’ Us an ‘experience’ for customers. Management’s bold move is seen as a last ditch effort to compete against ecommerce giant Amazon and begs the question: Where did Toys ‘R’ Us go wrong?

In 2005, private equity firms KKR and Bain Capital bought Toys ‘R’ Us for $7.5billion using a strategy called ‘the leveraged buyout.’ A leveraged buyout is when a company acquires another by using a significant amount of debt, often with funds borrowed against the assets of the company being acquired. To fund the acquisition KKR and Bain Capital committed $1.3billion in capital, assumed $1billion of Toys ‘R’ Us debt, and raised another $5.3billion in debt with Toys ‘R’ Us assets as collateral. By the time the acquisition was complete, debt accounted for over 80% of total capital and the interest expense was nearly double company net profits.

KKR and Bain Capital assumed that they could cut costs to improve Toys ‘R’ Us cash flow and sell assets to pay down debt. However, management didn’t consider the speed in which online retailers would enter the marketplace and hadn’t set aside contingency money in the event that things didn’t go according to plan. Toys ‘R’ Us no longer had the resources to compete with traditional retailers, build a major online presence, and pay down debt. After years of struggling to survive, Toys ‘R’ Us filed for bankruptcy on October 2nd, 2017.

3 Lessons we can learn from Toys ‘R’ Us’ mistakes:

  1. Plans may deviate. No matter how well developed your plan is, sometimes unforeseen events take place that can set you off track. When you miscalculate or get off track, it is important to quickly determine a new course of action.
  2. It’s better to be safe than sorry. Contingency funds provide you with greater flexibility and enable you to weather short-term storms, getting you back on track sooner.
  3. Anything that can’t last forever, won’t. Plans should be based on sensible forecasts, goals and aspirations. If it is too good to be true, it very well may be.

When Toys ‘R’ Us filed for bankruptcy protection, Dave Brandon (CEO) came out saying that the filing marked “the dawn of a new era” as it would free the company from crushing debts. Unfortunately for Toys ‘R’ Us, debt is a symptom of much deeper woes for the Company. Let’s hope Dave learned a lesson about debt management during this process or Toys ‘R’ Us may not be around much longer.

 

Devin Cattelan

Investment Advisor

Cattelan Private Wealth Counsel

HollisWealth®, a division of Industrial Alliance Securities Inc.