the Toys R Us Chapter 11 filing

Toys R Us (TRU) is no longer a publicly traded company.  After a very rocky period of being buffeted by Wal-Mart, Target, and with Amazon beginning to pile on, TRU was taken private in 2005.

Its fortunes haven’t improved while in private equity hands.  In addition, as private equity projects usually do, TRU acquired a huge amount of debt, as well.  In a situation like this, suppliers are typically very antsy about the possibility of a bankruptcy filing.  That’s because trade creditors have little standing in bankruptcy court; they usually can’t get either their merchandise back or payment on any receivables due.

When a reent press report appeared that TRU was considering Chapter 11, suppliers apparently refused to send any more merchandise to TRU on credit, demanding payment in full upfront instead.  The company didn’t have the cash available to pay for enough merchandise to fill its stores in advance of the all-important holiday season.   So it filed for Chapter 11 bankruptcy.

None of this is particularly strange.  Years ago, one of my interns did a study that showed that even in the early 1990s TRU was losing market share to WMT and TGT, and was making due mostly by taking share from mom and pop toy stores.  Then the last mom and pops closed their doors and TRU’s real trouble began.

What dd surprise me was the report in today’s Financial Times that the company’s notes due in 2018 were trading at close to par a couple of weeks ago–vs. $.28 on the dollar now.

How could this be?  Holders were apparently betting that TRU would limp through the holidays and then refinance its 2018 debt obligations–allowing these “investors” to collect a coupon and exit if they so chose.

The fact that professional investors would commit money to this threadbare investment thesis shows how desperate for yield they are in fixed income land at present.  As/when rates begin to rise, things could easily get ugly, fast.

Toys R Us redux (ii)

memory lane…

I took an international banking course in business school, way back when.  A case study of a project loan made by an international bank consortium to New Zealand made a profound impression on me as I was beginning to understand how banks work.

The loan was to enable the government to develop an offshore oilfield.  Borrowings were secured by the assets of the project; repayment was required to come solely from project revenues.  The key aspect of the loan, however, was that the loan principal came due at the end of year five but the first revenue from the project was expected to come only in year six.  

In other words, it was obvious to anyone who read the loan documents in even a cursory fashion that the original loan could never be repaid.  Not to worry, however.  This was the beauty of the transaction.  It guaranteed that a lucrative (for the main underwriters) refinancing/restructuring had to take place in year three or four.  The borrower may–or may not–have understood.  But these were the best terms it could get.

Loans like this ultimately led to the 1970s emerging markets debt crisis.

…and Toys R Us (TOYS)

…which brings me back to TOYS.  According to the Wall Street Journal, TOYS is trying to refinance $1.6 billion in junk bonds that come due through between now and 2018.  The company is at the leading edge of $1.3 trillion in junk debt coming due in escalating yearly amounts between now and 2020.  As the WSJ points out, TOYS’ experience in getting its refinancing done over the next two months or so will give an indication of how bumpy the road will be that other junk-rated borrowers will have to travel in the near future.

Although I worked side by side with junk bond fund managers for years, I’m not an expert.  Nor are many financings as cut and dried as the New Zealand one I described above.  But I have learned a bit over the years about human nature and about how financial firms work.  I’m convinced that a hefty chunk of the $1.3 trillion in junk where principal repayment is coming due over the net three years was issued with the expectation that refinancing would be necessary.  (I’m also confident that the offering documents contained a boiler plate warning about this possibility  …and that many buyers skipped over these pages, either from laziness or because they knew that was the way these transactions worked. )

Unlike the emerging markets debt crisis of a generation ago, I don’t think a potentially serious problem with junk bonds today is the same kind of threat to world economic growth that the 1970s lending crisis was.  But it could be a nasty bump in the road for junk bond funds and for the private equity firms that control companies who have been big junk bond borrowers.

We’ll know more in a month or two.

 

Toys R Us redux

Toys R Us (TOYS (not a ticker symbol today)) has been an iconic name in retailing over the past forty years.

–In the 1970s urban department stores came under attack by upstart specialty retailers who extracted the most profitable “departments” from the older merchant conglomerates and opened stand-alone locations focused on a single line of goods in direct competition with their older rivals.  More nimble, with a wider selection, often lower-priced, more willing/able to follow customers to the suburbs, specialty retailers ate the department stores’ lunch for years.  Many still do.

Toys were at the top of the extraction list.

TOYS was the first of the three contenders (the others were Child World and Lionels Kiddie City) to complete a nationwide retail network yielding the economies of scale that eventually won out against the other two.  As such, TOYS is a textbook case of the successful 1980s retailer.

It took market share both from department stores and mom-and-pop toy retailers.

–The 1990s saw the rise of Wal-Mart (WMT) and Target (TGT), who, more modern versions of the department store, used their floor space in a flexible way than their predecessors.  Their toy departments were relatively small for most of the year, but expanded dramatically during the holiday season–meaning, in contrast to TOY, they had toy overhead expenses for only a small part of the year.  Because they had other lines of merchandise to sell, they could (and did) use the hottest toys as loss leaders, as well.

For the first half of the decade, TOYS steadily lost market share to WMT and TGT but made it up by taking share from mom and pops.  Then there were no more m&ps   …and TOYS’ underlying competitive issues became more evident (there are a lot more wrinkles to the story–like store locations–but I think WMT and TGT were the main plot line).

–In 2005, TOYS was taken private in the first of a series of attempts to reorganize or restructure the firm to restore its past glory.

 

today TOYS is back in the news as markets worry about the firm’s ability to refinance its substantial junk bond borrowings.  It’s now being looked at as a possible canary in the coal mine for future troubles in sub-prime debt.

More tomorrow.