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.
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.