Rebekka Dunlap

Ann Marie Reinhart was one of the first people to learn that Toys “R” Us was shuttering her store. She was supervising the closing shift at the Babies “R” Us in Durham, North Carolina, when her manager gave her the news. “I was almost speechless,” she told me recently. Twenty-nine years ago, Reinhart was a new mother buying diapers in a Toys “R” Us when she saw a now hiring sign. She applied and was offered a job on the spot. She eventually became a human-resources manager and then a store supervisor.

She stayed because the company treated her well, accommodating her schedule. She got good benefits: health insurance, a 401(k). But she noticed a difference after the private-equity firms Bain Capital and Kohlberg Kravis Roberts, along with the real-estate firm Vornado Realty Trust, took over Toys “R” Us in 2005. “It changed the dynamic of how the store ran,” she said. The company eliminated positions, loading responsibilities onto other workers. Schedules became unpredictable. Employees had to pay more for fewer benefits, Reinhart recalled. (Bain and KKR declined to comment; Vornado did not respond to requests for comment.)

Reinhart’s store closed for good on April 3. She was granted no severance—like the more than 30,000 other employees who are losing their job with the company.

In March, Toys “R” Us announced that it was liquidating all of its U.S. stores as part of its bankruptcy process, which began last September. Observers pointed to the company’s struggle to fight off new competition. In its court filing, the company laid the blame at the feet of Amazon, Walmart, and Target, saying it “could not compete” when they priced toys so low.

Less attention was paid to the albatross that Bain, KKR, and Vornado had placed around the company’s neck. Toys “R” Us had a debt load of $1.86 billion before it was bought out. Immediately after the deal, it shouldered more than $5 billion in debt. And though sales had slumped before the deal, they held relatively steady after it, even when the Great Recession hit. The company generated $11.2 billion in sales in the 12 months before the deal; in the 12 months before November 2017, it generated $11.1 billion.

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Saddled with its new debt, however, Toys “R” Us had less flexibility to innovate. By 2007, according to Bloomberg, interest expense consumed 97 percent of the company’s operating profit. It had few resources left to upgrade its stores in order to compete with Target, or to spiff up its website in order to contend with Amazon. “It’s true that they couldn’t respond to Amazon,” Eileen Appelbaum, a co-director of the Center for Economic and Policy Research, told me. “But you have to ask yourself why.”

Shortly after the buyout, the company’s CEO implemented a plan to combine and remodel Toys “R” Us and Babies “R” Us locations. Customers liked the changes, but the company was able to revamp only 146 of its more than 1,500 stores by 2010. By that point, it was facing the effects of the Great Recession. Most retail operations try to keep their debt burden low to be ready for an inevitable downturn; when you sell a product as discretionary as toys, a recession can hit particularly hard. Thomas Paulson, the founder of the investment firm Inflection Capital Management, which focuses on companies that serve consumers, told me that when the retail landscape shifts, a company may need to make investments and even adapt its business model to stay afloat. If it’s already carrying significant debt, it’s “really handcuffed,” he said. “That’s what happened with Toys “R” Us.”

Josh Kosman, the author of The Buyout of America, agrees: “All it takes is for earnings to stop rising and level off, or even decline a little bit, and you’re in a whole heap of trouble.”

Toys “R” Us is hardly the only retail operation to learn this lesson the hard way. The so-called retail apocalypse felled roughly 7,000 stores and eliminated more than 50,000 jobs in 2017. For the spate of brands that have recently declared bankruptcy, their demise is as much a story about private equity’s avarice as it is about Amazon’s acumen.

In April 2017, an analysis by Newsday found that of the 43 large retail or supermarket companies that had filed for bankruptcy since the start of 2015, more than 40 percent were owned by private-equity firms. Since that analysis, a number of others have joined the list, including Nine West, Claire’s, and Gymboree. An analysis by the firm FTI Consulting found that two-thirds of the retailers that filed for Chapter 11 in 2016 and 2017 were backed by private equity.

“Had these companies remained publicly owned,” Paulson said, “they would have had a much higher probability of being able to adapt, to invest, and to withstand” the ups and downs of the economy.

A private-equity takeover is akin to a family’s buying a house: A firm contributes what is essentially a down payment using its own funds and then finances the rest with debt. But in the case of a buyout, the firm doesn’t have to pay back the mortgage; instead, the company it bought assumes the debt.

Private-equity firms enjoy the misperception that they swoop in and save struggling companies from the verge of ruin. They’ve long held the promise of benefiting these companies through close monitoring—and debt, the theory goes, should impose discipline on managers. That’s the model followed by a few specialty firms, but it is far more common for private-equity firms to seek moderately successful targets where they see an opportunity to increase profit margins. After a few years of slimming costs and boosting revenues, the goal is to off-load the company, by either helping it go public or selling it.

In some instances, private-equity firms lend know-how that allows a company to operate more efficiently or expand beyond a small niche. “There’s a role for private equity in certain industries that are experiencing disruption,” Angela Kapp, an investor who sits on the boards of private-equity-owned companies, told me. One of the more celebrated retail buyouts was KKR’s acquisition of Dollar General, in 2007. After bringing in a new management team that made changes such as upgrading the quality of the company’s products and tailoring them to its customer base, the firm helped it go public. It now has the most stores of any U.S. retail chain. Firms “bring resources and capabilities and [have] seen the movie before,” Kapp said.

But that doesn’t mean the movie always has a happy ending. “I don’t even know if there are that many success cases in retail,” Sucharita Kodali, an analyst at the market-research company Forrester, told me. She allowed that Toys “R” Us was hardly in great shape before its acquisition, but says the buyout only made things worse. “I think it probably hastened their death,” she said. Even Dollar General’s success, she argued, had a lot to do with timing and the particular corner of retail it occupies—the recession pushed consumers toward its discount stores.

Given private equity’s poor track record in retail, it can be difficult to see what companies like Toys “R” Us hope to get from a buyout. For private equity, however, the appeal is clear: The deals are virtually all upside, and carry minimal risk. Many private-equity firms chip in only about 1 to 2 percent of the equity needed for a leveraged buyout, and skim fees and interest throughout the deal. If things go well, the firms take a huge cut of the profit when they exit. If everything blows up, they usually still escape with nary a burn. Toys “R” Us was still paying interest on loans it got from KKR and Bain up until 2016, as well as millions a year in “advisory fees” for unspecified services rendered. According to one estimate, the money KKR and Bain partners earned from those fees more than covered the firms’ losses in the deal.

Private equity can stack the deck in other ways, too. Firms can direct businesses they own to buy other companies and then act as broker on the deals, reaping transaction fees. After its buyout, Toys “R” Us acquired a number of companies, including FAO Schwarz, eToys.com, and assets from KB Toys (itself a failed reclamation project of Bain’s). Consolidating brick-and-mortar and online toy businesses may have been a good-faith strategy. What’s certain is that the deals helped generate $128 million in transaction fees for the owners.

So far, private equity’s string of failures in retail hasn’t caught up with it. Pension funds and institutional investors keep coming back to the promise of a 12 percent (or greater) return on investment, well above what’s offered by bonds or even public companies. But creditors and vendors left holding the bag when retailers go out of business don’t have much recourse.

One success story: Private-equity firms helped buy out the retailer Mervyn’s in 2004, loading it up with $800 million in debt and spinning off its real-estate holdings. The company went bankrupt in 2008 and liquidated its stores, yet according to bankruptcy-court filings, its owners pocketed $200 million in fees and dividends from 2004 to 2006. Vendors such as Levi Strauss, which had sold clothes to the retailer and wanted to be paid for its goods, sued the private-equity owners. They secured a $166 million settlement, arguing that the owners had played a role in driving Mervyn’s into bankruptcy. (The owners did not admit any wrongdoing.)

In other countries where private equity has a meaningful presence in the market, it operates with more restrictions. Germany and Denmark guarantee that most workers receive severance, making it far costlier for a private-equity firm to seek layoffs to increase profit margins. In the U.S., labor campaigns have successfully pushed a number of retailers to pay more, offer better benefits, and improve their scheduling practices. But the sector’s instability is throwing these gains into question, and some reformers would like to see even more radical change. A conglomeration of workers’-rights and financial-reform organizations is seeking to outlaw leveraged buyouts altogether. “They weren’t always legal,” Charles Khan of the Strong Economy for All Coalition, which is part of the group, points out. Before the 1980s, companies couldn’t finance deals with such high levels of debt. One aim of Khan and his allies is to once again force buyouts to rely on a smaller portion of debt. “The economy has existed long before private equity,” he says. “I think it can exist without private equity.”

Political solutions, even more-modest ones, could be a tough sell in Congress. Private-equity firms shower a lot of money on Republicans and Democrats alike. They’ve also made the most of the revolving door between the public and the private sectors: Barack Obama’s Treasury secretary Tim Geithner is now the president of the private-equity firm Warburg Pincus; Donald Trump’s commerce secretary, Wilbur Ross, founded a private-equity firm in 2000.

While their demands may prove overly ambitious, reformers are clear-eyed about what will happen without a change of some kind. Retail companies face billions of dollars in debt coming due in the next five years, much of it thanks to leveraged buyouts. More bankruptcies are on the way.

Toys “R” Us workers are making the case for severance pay directly to lawmakers. In early May, Ann Marie Reinhart and other former employees met with Senator Bernie Sanders and Representative Keith Ellison. Next, they’ll take their demands to KKR, Bain, and Vornado. “We’ve given blood, sweat, and tears to this company,” Reinhart told me. “So to walk away with nothing, it’s just humiliating.”

In the meantime, Reinhart is looking for work. She hopes she won’t have to take another job in retail. “I could not go through this again,” she said.


This article appears in the July/August 2018 print edition with the headline “You Buy It, You Break It.”