Toys ‘R’ Us: A Simple Explanation

The Toys ‘R’ Us closing wasn’t a result of kids wanting fewer toys or adults buying fewer toys, or even Amazon or other retailers taking a bite out of the toy market. It was because a bunch of rich old dudes decided to pump and dump the brand with debt.

Here’s the technical description of what happened, according to Seeking Alpha:

“In 2005, Toys ‘R’ Us was purchased by a consortium of private equity companies in a leveraged buyout (LBO). In a leveraged buyout, a financier – in this case private equity companies – purchases a company using borrowed funds, or leverage, rather than the financier’s own assets. The LBO left Toys ‘R’ Us with $5.3 billion of debt, secured through the company’s assets.

This brought the company’s total debt up to $6.2 billion when accounting for the $1 billion Toys ‘R’ Us had previously accumulated. The interest rate of the LBO was around 7.25 percent, leaving Toys ‘R’ Us with annual interest payments of $450 million, nearly double its annual net profit.”

Let’s rephrase this into plain English:

Meet Little Suzie. Little Suzie has a lemonade stand.

It’s doing well, even despite a Starbucks and several grocery stores that serve bottled lemonade within driving distance of her house.

To start her business, she borrowed money from Mom to buy cups, a pitcher, lemons, and water. She had a bit of her own capital to buy sugar and a citrus reamer.

Suzie’s earning money, and is slowly paying down the debt on the initial loan she acquired from Mom – it isn’t insurmountable and paying it back plus interest accounts for a small-ish portion of her annual revenue. She’s making good choices and selling well even when it’s cooler, because everybody likes Suzie. 

A year or two in, Suzie decides she wants to spend more time with Fido and it’s time to sell the biz.

Enter Brock, slick-talking, lots of money, and stupid, except for plans to make more money. Brock convinces the other neighborhood kids to give him $10 which he’ll turn into $50 for them. So they give him the money and he “buys” Suzie’s brand with this borrowed money.

Brock hires local kids to manage the brand and after (sometimes) meeting their expenses, they now pay 100%+ of their earnings back to Brock who takes a cut while paying debt.

Suzie’s lemonade stand can’t upgrade cups, add new reamers, experiment with new branding, or buy syrup for new flavors – all their money is tied up in paying down debt. Suzie’s goes downhill and eventually closes.

Brock, jackass that he is, can write off the loss because it wasn’t his money and all investment carries some risk. Brock still made money from nothing by taking a cut of the debt payments as the “manager”.

The neighborhood kid investors are only out ten bucks for their effort, and can easily recoup that when Brock sells off Suzie’s inventory – the remaining lemons for $1 each, the reamer for $30, the table for $25, the sugar for $3/bag, and all the cups as exclusive “last-chance” nostalgia items. Brock takes another cut for himself and pays back the investors.

Shitty business people making shitty decisions. That’s what killed Toys ‘R’ Us.

Creditors and the private equity companies were making money because the money they used to buy the biz wasn’t theirs and they could write off the “investment” as a loss while still getting paid. When Toys ‘R’ Us closed, they could sell off the inventory and make back almost all of their investment.

OK, but what about Amazon, Target, Walmart, and the other stores supposedly eating Toys ‘R’ Us’ lunch? Didn’t that, like, cause some problems?

According to Bloomberg: “What’s fascinating — or unsettling — is that overall revenue at Toys “R” Us didn’t fall all that much, even during and after the recession. In the 12 months leading up to the LBO, the chain generated $11.2 billion of sales, versus $11.1 billion in the 12 months through October 2017, according to data compiled by Bloomberg.”

That is: Toys ‘R’ Us sold almost just as much during a recession. Nobody was eating their lunch. They were holding their own, so it bears repeating:

Shitty business people making shitty decisions. That’s what killed Toys ‘R’ Us.

Saddled by debt, Toys ‘R’ Us couldn’t do anything to improve their stores. They couldn’t slim down their storefronts and still pay off the debt. They couldn’t consolidate any product lines, because they couldn’t afford to acquire new licenses and exclusives.

The brand was being slowly strangled to death by bad business. That’s the takeaway.

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